Let’s face it, you made the choice to be a business owner for one simple reason: to get paid. Sure, you may feel passionate about what you do but the bottom line is you chose to be a business owner because you hoped that there would be cash for you. So how should you go about getting the cash from your business into your pockets?
Many business owner’s make the mistaken assumption that since they own the business, they can take money out whenever and however they want. The reality is that without proper understanding you may trigger unpleasant consequences that include additional taxes and/or personal liability exposure.
There is not one right answer for every situation, this article is an attempt to briefly cover the most common methods based on business entity type.
Sole Proprietorship: Sole proprietors do not take W2 wages or distributions but may take money out of the business account with no tax impacts.
Partnerships: Partners do not take W2 wages but can receive guaranteed payments instead. Guaranteed payments are like wages except there is no withholding taxes. The applicable payroll taxes will be computed at time of tax filing. Partners may also receive cash distributions tax free but be careful here as there may be consequences if the distributions exceed the basis.
S-Corporations: S-Corp Shareholders can and should take reasonable W2 wages. However, many of the benefits available to employees (such as cafeteria plans) can be limited with respect to a greater than 2% S-Corp Shareholder. Provided a reasonable wage is being paid, distributions may also be tax free as long as they do not exceed the basis.
C-Corporations: C-Corp shareholders can take W2 wages and also participate in employee benefits plans. The downside is that distributions are replaced with taxable dividends for shareholders.
Regardless of whatever type of entity you are there are some things that should be avoided.
First, don’t mix business funds with personal funds. Paying business expenses from personal accounts and paying personal expenses from business accounts can lead to major tax and legal trouble for small businesses.
Second, if you are going to borrow or loan money to your business be sure to adhere to the formalities that may be required.
Now that you know some simple ground rules, get your business out there and make your cash just use caution and where possible consult with a tax professional before putting it into your pocket.
Sam Clegg CPA