How And When To Pay Yourself From Your Entity

The key is to get the business in a position as soon as possible to pay yourself from your business

. That involves many steps.

1.The business needs to generate revenue to pay the bills of the business. Obtain a business credit card in the name of the business under the EIN number. This business credit card should cover all the reoccurring expenses for your business. Your challenge at this point is to determine your cash flow in sales (which may be really up and down the first three to six months in business).

2.Let us assume, it is month three in your business and you are starting to have consistent sales. Now the business bank account balance is starting to increase and you are at the point to consider paying yourself. That is great news.

3.Let us cover the different entities and the options to pay yourself:

An LLC taxed as an S corporation. This is an LLC for legal purposes but taxed as an S corporation. That means that all profits (or losses) will flow through to the owners of the LLC taxed as an S corporation which is typically an individual. Key point: Whether or not the LLC actually writes a check from the LLC to you personally does not affect the end tax result. The profit or loss will flow through via a K-1 to the owners. In other words, you will not save on taxes by not writing a check from the LLC to you as the owner. The S corporation will flow money through either as payroll or as distributions in profits.

The key with an S corporation is to pay a reasonable salary. If you look at a year glance this may be easier to determine. For example, if you are planning to gross $200K in revenue with $100K in profits before you pay yourself, you can estimate that $40K of the $100K would be a good reasonable salary amount and the other $60K would flow through as distributions to you throughout the year. It would not make sense to get "greedy" and take a low salary of $10K and distributions of $90K to save more of the 13.3% employment taxes. The IRS will watch out for that with S corporation.

The most common question I get asked is; it ok to do just pay myself a distribution check every few weeks until the entity is in a position to do payroll. The answer is yes. What is a distribution? That is where the LLC will write a check out to you. In the memo you will write the word distribution. This is also known as non-passive income. You can write a distribution for $500 one week, skip three weeks and write another check for $200 and three weeks later write a check to yourself for $1,000. The mistake comes when six months go by and you have not started any payroll. There are a lot of steps involved with payroll taxes both at the state and federal point of view.

Keep in mind if the entity is an LLC taxed as a partnership, there is NO PAYROLL to the members (or partners). There is a term called a guaranteed payment to the manager of the LLC (which is subject to similar taxes as payroll). This is like a type of salary that is paid consistently before any profits are distributed and they are subject to employment taxes.

The C Corporation. A C corporation has separate tax brackets and will pay taxes on profits at the corporate level A C corporation will file an 1120 federal tax return vs an S corporation that files an 1120S federally. There are two common ways to take money out of a C corporation, that is a salary or dividends. A salary is an expense to the corporation (just like in an S corporation) that lowers profits. The earned income is subject to the employment taxes which are 13.3% up to $106,800. Dividends are not subject to self-employment taxes (but it is not an expense to the corporation). This is important to note (same with an S corporation).

In the C corporation your goal is to pay most of the profits out as salary (unless you need the profits for growth and expansion. The concern for having too much profits left in the C corporation is that it will be taxed now and later may be subject to double taxation if you are planning to take that money out of the corporation.

Coming back full circle the first goal is to develop revenue consistently to cover the expenses of the business. Next is to get in a position where the business can pay you a distribution (or salary in a C corp) and work up to a salary in an S corporation.

by: Scott Letourneau

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