Controlling Your Money Flows And Paying Yourself
OK, this post is where we are going to get a little technical. But it’s ok, because this is where the magic really happens with owning your own business.
Today we are going to talk about money flows and how, by making some tweaks, we can change how, and even IF money flows, are taxable. I would like to point that I have not yet suggested, or told you, to get a business entity.
This is me telling you to get a business entity.
There are three major types: C-Corp, S-Corp, and LLC. There are a million places to get an explanation of these, so I won’t go into it here. Suffice it to say that C-Corps pay their own tax, and S-Corps and LLCs “pass through” their taxable income to the owner, so it is only taxed once. We also need to understand a few terms:
- Gross Revenue or Income is the total amount of money your business brought in.
- Profit is what your company has after paying expenses.
- Taxable Income (for our purposes) is the same as profit.
- Payroll, Wages, W-2 is money paid to people (including the owner) that is deducted from the Gross Revenue, which lowers your Profit. This is taxable income to whomever it is paid to.
- Dividend is paid from a C-Corporation. It is NOT a deduction for the corporation and is taxable income to the payee (this is the double taxation problem).
- Distribution is taken from an S-Corp and is tax free. It MUST be taken in proportion to ownership.
- Draw is taken from an LLC and is tax free. It does not necessarily have to be taken in proportion to ownership.
OK! So here we go:
You want to bring is as much gross revenue as you can. Go make your business bigger and make more money!
Once that income is in your business, our goal is to spend as much of it inside your business entity as possible. This is because everything you spend at the corporate level reduces your profit. There are a lot of things that your company can do for you, its valuable employee, to ensure you keep working hard for it. For example, it can provide you with a company car and a cell phone or provide you with money for meals and entertainment expenses. Many of these are considered non-taxable fringe benefits. That means you can deduct them in the company, but you don’t have to declare them as income personally. Once you have spent all of the money you can in the business entity, you have to figure out how to get the money out of the business entity so you can spend it on personal expenses or save it.
If you have a C-Corporation, then you have to pay yourself a Wage to get money out of the entity so you can use it for personal expenses. Or you can pay tax at the corporate level and then take a dividend (which will be taxed again).
If you have an S-Corporation, you can take a Distribution of any profit in the company to yourself personally. Be aware that you will be taxed on the profit of the company, whether you take it in a distribution or not.
If you have an LLC, you can take a Draw of any profit in the company to yourself personally. Be aware that you will be taxed on the profit of the company, whether you take it in a draw or not.
It can get more complicated from here, with non-cash expenses (like depreciation), non-deductible cash expenditures (like federal taxes), accounts receivable and accounts payable. All of these things can disassociate cash from taxable income. I won’t lie to you: You need a professional to help you with this part.
The other money flow you should learn to control is your savings. When (notice I said WHEN not IF) you start generating more profit than you need to pay your bills, you should consider moving money into a qualified retirement plan like a SEP, SIMPLE, IRA, or 401(k). This will allow you to defer paying taxes on the profit until you need the money (like in retirement). Again, you need a professional to help you figure out what kind of plan is best for you.
And it’s THAT SIMPLE folks. Don’t over complicate it!
Other articles in the So You Want To Run Your Own Business series: