As a business owner, you want to strike the most effective balance possible when it comes to your company’s finances. Doing so can ensure your operation’s financial foundation remains strong, regardless of how the broader economy is faring. From controlling costs without unreasonably compromising quality to paying workers enough to incentivize excellent performance, without paying them so much that your bottom line suffers, striking the ideal financial balance isn’t easy.
In this article, the skilled CPAs at Ferguson Timar discuss how to find this financial sweet spot when it comes to the tax treatment of income earned from your business. As there is no one-size-fits-all solution to this concern, the techniques you may need to employ for the benefit of your company may be different from those other successful ventures use. Yet, by giving thoughtful consideration to the information below, you’ll be better positioned to optimize your tax strategy to keep more of your company’s hard-earned income in your coffers—and your pockets—where it belongs.
Sole Proprietorships
If you are a sole proprietor, your company’s income is taxed—as a matter of course—on your personal tax return. As a result, your primary concerns need to be:
- Tracking every single expense related to your operations
- Keeping accurate financial records at all times
- Taking advantage of all available tax deductions
By utilizing the services of a skilled CPA, you can better ensure your company’s tax strategy is optimized for your benefit.
Partnerships
Partners are subject to a specific interest in their company, unlike sole proprietorships responsible for the whole of theirs. As such, partners can opt to take salary, distributions, or both. Salaries are taxable income. Generally, partnership distributions aren’t taxed because partners pay taxes on the overall income generated by the organization on their personal returns. However, there is an exception to this rule. If a partner lays claim to a distribution that exceeds their net share in the value of the partnership, the excess amount is classified as taxable income.
Limited Liability Companies
The tax-related consequences of salary vs. distributions become more complex in the event that a business is structured as a multi-member LLC. As always, salaries are taxable income, but they cannot generally be avoided because most people are not so affluent that they can afford to simply absorb distributions whenever they become available, instead of taking a regular salary.
With that said, proportionate profit distributions may be taken when appropriate, as distributions must be made to all members when they are initiated, according to the interest share of each member. Like in partnerships, LLCs aren’t generally taxed because LLC members are responsible for tax liability on the profits generated by the company more broadly.
Corporations
Corporate distributions are significantly different from those offered by other business structures because many—if not most—shareholders in a corporation may not be in a position to take a salary. Those who work for a corporation where they are also shareholders can avoid payroll taxes by taking distributions instead of a salary. Yet, because corporate distributions made after taxes are paid on a company’s profits, distributions are taxable income for those who receive them. In essence, you’ll likely be paying taxes whether you take a salary, distributions, or both, unless you use highly specific investment strategies alongside keeping your salary extraordinarily low, so you’ll want to speak with a CPA on our team about the nuances of your situation to optimize your tax strategy according to the ins and outs of your unique circumstances.
Allow Ferguson Timar to Perfect Distribution Timing
Salaries, which are a business expense, must be accounted for before distributions are made. Once all company expenses have been met, a distribution potentially can be made, but that timing should reflect forward-facing concerns. For example, offering a distribution when depleting the company’s cash reserves, rendering it uniquely vulnerable, is a poor decision. Distributions, although they can result in certain tax benefits, need to be timed with care. Speaking with our team before initiating a distribution at your place of business can preserve the company’s interests and safeguard yours.
Whenever you have concerns about tax strategy optimization, know the reputable CPAs at Ferguson Timar are available to assist you as an individual and as a business owner. Contact our team today at (714) 204-0100 to begin discussing how to optimize the tax treatment of income from your business, regardless of how it is structured. We look forward to speaking with you.