Why your salary and distributions are a fogging your view of net income - Simple Numbers, Straight Talk, Big Profits! Chapter 1
I have always said that the most important thing a business person should know is their numbers. Simple Numbers, Straight Talk, Big Profits! teaches us how to understand our financial numbers, as our understanding will determine our profitability.
This book is designed for businesses that have an annual revenue of anything from zero to five million dollars. The first section of the book is divided into four chapters that outline the main recurring problems that businesses with revenue of up to five million dollars have.
Owner Salary: Why your salary and distributions are a fogging your view of net income.
Entrepreneurs often misunderstand the relationship between their salary and the return on what they own. Author Creg Crabtree states that all of his clients have confused the profits of their business with their salary. Remember the key distinction: You get paid a salary for what you do and you get a return on what you own.
Why is this so important? If you don’t pay youreself a market-based wage, your net income number is lying to you; until you pay yourself a market-based wage and plug that number into your financials, your financial data is worthless. Before you start to worry, about 90% of all entrepreneurs are paying themselves less that the market speculates for the position.
I know you all are not going to like this, but keeping Uncle Sam happy may be your best key indicator.
When you don't pay yourself a market-based wage your financials are distorted and the IRS takes notice.
If you are a profitable S corporation and you pay yourself a low wage, you run the risk of an IRS audit. According to the author, during the last two years the IRS has audited the returns of thirty thousand S corporations based on this one issue.
There is never a case in which the entire next dollar of profit goes to taxes. The top federal tax bracket is 35 percent, so you keep 65 cents on every dollar. If you are an LLC then all of your profits are subject to an employment tax, so the IRS doesn’t care how much you take in salary or distributions. If you are an S corp, however, this is a red flag because the IRS will say the distributions should be salary.
You should not pay yourself a market-based salary when your business cannot afford it, you should pay yourself in sweat equity. Sweat equity is the value you have created for your business through your unpaid work.
Chapter 1 key:
1. Know what your market-based wage is for your role.
2. If you are profitable, and you pay yourself wage that is too low, you run a high risk of an IRS audit.
3. Value profitability over tax saving.
4. Use market-based wages for everyone in the business, including shareholders.
5. Payback your investors before you share profits and create reasonable financial expectations for your investors.
6. Consider working in a limited capacity at a lower wage as you transition out of active management.
REMEMBER; READING IS TO THE MIND, WHAT EXERCISE IS TO THE BODY! TAKE CARE, CONSTANCE