The Owner’s Paycheck: How to Get Paid from Your Company
The form of ownership that you choose to operate your business under will determine the method in which you pay yourself a salary. Making this decision in the start up phase requires much research and should be handled with care. We choose our form of ownership, mainly based on the potential tax consequence that we expect. Of course, our goal is to pay as little taxes as possible into the system, so the form of ownership chosen helps to achieve this goal. There are clear advantages and disadvantages based on each method available.
As a small business, many people survive from the earnings from operations. But the key here is to remember to keep your business and personal expenses separate. So the questions is, “How do I pay myself, and what impact does it have on my taxes?” Let’s look at some of the ways a business owner can pay themselves a salary from the earnings of their business.
Sole Proprietors and LLCs
Taking money out your business or paying yourself under these forms of ownership, the owner will be responsible for self-employment taxes on any profits that remain in the business whether withdrawn or not. Because this income is not subject to withholding, the owner could also become responsible for making estimated quarterly tax payments. The estimated tax payments will account for both the self-employment tax along with income tax. The self-employment tax is the equivalent of what an employer’s payroll tax would be for FICA and Medicare. The disadvantage here would be that the owner is fully responsible for the entire tax, whereas corporations are not. The corporation is only responsible for half of the FICA taxes; Social Security (12.4%) and Medicare (2.9%) tax; with the employee paying the other half.
Many owners become confused because they believe that since they are paying the self employment tax, that they are not subject to any further taxation. This is not true. The money you withdraw from your business is still subject to income taxes and you must report this income on your form 1040. The key point to remember here is that, although you are not subject to payroll taxes, you are still required to pay into the system by way of self employment and income taxes. The advantage here is the owner gets a deduction on its taxes for paying self employment taxes, where the owner of a corporation doesn’t. For tax purposes you can elect to have your LLC taxed as a corporation, but be aware that making this choice involves very complex rules and regulations. It’s best to stick with what makes sense for you.
Corporations
If you are established as this form of business, the payment to yourself would be made in the form of a salary through payroll. Under this method, you are subject to payroll taxes, which include income (federal and state), and FICA (Social Security and Medicare). One of the key advantages of corporations is that the owners are not liable for self-employment taxes for profits retained in the business. As with Sole Proprietorships and LLCs, you saw that profits are taxed whether paid out or retained in the business. However, a corporation will be subject to unemployment taxes for both federal and state. The employee does not share in this expense. So, the difference here comes in the classification of a corporation being an entity separate from its owners. Because of this, it has an entire different tax profile than the Sole Proprietor or the LLC. The corporation and its owners are taxed separately. Each must file its own tax form.
Deciding on your method of payment simply comes down to how it must be reported for tax purposes. Take the time to do the research so that you can choose the best method based on your company’s profile.
Partnering for your success!
Jacqueline E. Williams
Financial Strategist
What Accounting Basis means for your business
Deciding on which basis of accounting to use for your business will determine how you record your transactions in any given period. Of the several methods, whichever is chosen, the business owner must be consistent in its use thereof for tax reporting and bookkeeping purposes. In order to change, they must file a request with the IRS. The most common bases of accounting are the accrual basis, the cash basis, and the income tax basis.
The accrual basis of accounting records transactions in the same period of which the related transaction occurs, regardless of whether cash is received or not. For instance, if you purchase equipment in 2009, but don’t pay for it until 2010, under the accrual method you would still include the purchase on your books for 2009. The purpose here is to match the income and expenses in the same period. The IRS has clearly defined tests that outline these events. For instance, income is considered earned on the earliest date of these occurrences:
• When you receive payment.
• When the income amount is due to you.
• When you earn the income.
• When title has passed.
And expenses become deductible when:
• The all-events test has been met. The test is met when:
- All events have occurred that fix the fact of liability, and
- The liability can be determined with reasonable accuracy.
• Economic performance has occurred.
The cash basis of accounting records transactions when cash is collected or paid. Using the same example above is you purchase equipment in 2009, but don’t pay for it until 2010, under the cash method you would include the purchase in 2010, when cash is paid. Income includes amounts that you actually or constructively received and expenses include amounts that you actually paid or contest owing. But it does not include amounts that were paid in advance. Expenses paid in advance must be capitalized or recorded as assets.
The income tax basis of accounting is the method used to file your taxes. It’s a combination of the cash basis and the accrual basis. Although businesses are allowed to take this approach, the IRS does impose restrictions on its use. Some of those restrictions would be:
• If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales.
• If you use the cash method for reporting your income, you must use the cash method for reporting your expenses.
• If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income.
Whatever method you choose to report your income and expenses, it must be held consistent throughout. Just remember to choose a method that best reflects your reporting of income and expenses.
Partnering for your success!
Jacqueline Williams
Financial Strategist
Hooray for Ratios: The analysis paralysis of financial statements
Analyzing your company’s performance is crucial to making determinations surrounding your investment activities. The objectives you define are generally based on your company’s current and past financial performance. If you’ve ever heard of benchmarks, then you know that the results you determine from your analysis are useless unless you have something to compare them too. Analyzing your company’s financial activities involves using specific methods of investigation. Ratio analysis involves studying the relationship between two or more items on your financial statements. With ratio analysis you’ll be able to make key financial decisions such as; which areas need improvement, which areas are profitable, are you meeting your cash requirements, and are you meeting your obligations. The most common of these analysis are:
Current Ratio
Inventory turnover Ratio
Profit margin on sales
Days sales outstanding ratio
Debt to total assets ratio
Current Ratio
This ratio determines is a company is able to meet its current obligations. In other words, are you able to pay off your current liabilities? Typically a current ratio of 2:1 states that a company is able to meet its current obligations. Also known as the Quick Ratio, it is calculated by dividing current assets by current liabilities.
Inventory Turnover Ratio
This ratio evaluates your inventory and states how many time in a year your inventory is sold or replaced. A low ratio would imply that a company has excess inventory on hand. For example, if a company has an inventory ratio of 6.3, this would mean that inventory would have to be restocked at least 6 times in a year. In this example, sales are good because your products are moving. This ratio is calculated by dividing Cost of Goods sold by the average inventory. The average inventory is calculated by adding the beginning and ending inventory balances and dividing this total by two.
Profit Margin on Sales
This ratio determines how profitable a company has been. It is calculated by dividing the Net Profit for the year by total sales. When compared with prior periods, this ratio is revealing in that shows whether a firm is operating efficiently and able to compete successfully with its competitors. For example: if your net profit is 1,000,00 and your sales are 15,000,000,then your profit margin would be 6.67%. This means that for every dollar of sales, your company made .06 cents profit. When calculating this ratio be sure to reflect net profit which deducts cost of goods sold along with operating expenses.
Days sales outstanding ratio
Based on daily sales activity, this ratio determines how long it takes to get paid after making a sale. It is calculated by dividing the accounts receivable by the average sales per day. It’s important to monitor this ratio closely as it directly affects your cash flow.
Debt to total assets ratio
This ratio represents the total debt as a percentage of total assets. It is calculated by dividing total liabilities by total assets. A low ratio indicates that a company is more likely able to pay its creditors with a reduction in assets, whereas a higher ratio would mean that it would hurt the company to reduce its assets in order to make its payables.
There exist over 20 various ratios that company’s can use to examine and evaluate their financial standing. Using ratio analysis allows you to make decisions concerning credit, management style, and whether the processes chosen are effective in accomplishing the company’s goals.
Partnering for your success
Jacqueline Williams
Financial Strategist
Monthly Bookkeeping For Success Tele seminar
Each month Bookkeeping For Success hosts a tele-seminar with successful, innovative, motivated small businesses who are focused on creating an effective system for their bookkeeping.
March’s topic is
“Time Management Techniques using Quick Books”
This tele-seminar will introduce the concepts of time management and its techniques to help you manage your bookkeeping process better while using Quick Books.
You are welcome to email questions in advance to: eworkshop at jefinancialservices.com. In addition, we will provide an opportunity for you to ask questions during the tele-seminar.
Here are the details….
Date: Wednesday, March 25, 2009
Time: 4:00pm EST, 3:00pm CST, 2:00pm MST, 1:00pm PST
Reserve your seat at: Bookkeeping Success Tele Seminar Line
All you have to do to attend the tele-seminar series is find a comfortable spot for about an hour, sit back and connect with the Bookkeeping Success Tele Seminar Line. You’ll get to ask as many questions as you want during the seminar and even after. Plus, if you miss a session or the available times are not good for you there’s no need to fret because the entire event is recorded and you’ll have the ability to listen to it at your convenience.
I hope you’ll take advantage of this invitation and I’m looking forward to “seeing” you on the call.
Documenting is easy as 1-2-3
Many small businesses get caught in the whirlwind of falling behind in their paperwork because they have not discovered or utilized automation to make their bookkeeping process easier. Believe it or not, many feel that as long as they have the bookkeeping software in place (ie Quick Books), they have fully automated. This is not the case. Having software to track entries is one of the steps to full automation. Still, there is the process of organizing and categorizing your data before entering it into the system. This is where human error happens if you don’t have a basic knowledge of bookkeeping. For those who are still learning, there is an easier way. Automating various bookkeeping tasks will not only keep you up to date in your paperwork, it will also streamline your entire process and save you valuable time, which can be fully utilized in other revenue producing areas of your business.
There are various products on the market that aid in automating the documentation process and are able to be fully integrated with your current bookkeeping system. With these products, you will be able to scan, organize, and in some cases attach them to your bookkeeping transactions.
Smart Vault - this on-line document management system is available for a monthly subscription fee as low as $15. Being able to access this system anywhere anytime is a major plus for e-businesses. You will be able to scan, attach, share and store your documents all within Quick Books. There is no per user charge with this product, so you are only subject to the one low monthly fee. It is currently being offered with a 30 day no risk free trial.
PaperSave® - this document management system is a standalone module that must be installed on your system. Although it’s a little pricier, $195 for a single user, you will have the ability to integrate your records directly with MS Office products Excel, Word, Outlook, & PowerPoint. Having the same ability to scan, attach, share and store documents, the software holds it own by electronically storing over 200,000 documents.
Ultimate AppendIT - this software is unique in that it creates Windows folders on your PC in directories organized the same as QuickBooks lists. All documents, images, desktop shortcuts and web pages, which are placed in a folder, are easily linked to your QuickBooks entry. You maintain full control over what’s linked and how automated you want it to be. This is a standalone program that’s easy to install and only cost $24.95 to $49.95.
Managing your small business is very time consuming, so make sure you have the tools necessary to keep you ahead of the game. Automate wherever you can to give your company the competitive edge it needs in time management and document storage and retrieval.
Partnering for your success,
Jacqueline E. Williams
Financial Strategist