09 / 03 / 15

How to Geaux Local: Tips for Starting Up a Small Business

small bizSo, you’ve decided to take your favorite hobby and turn it into your new small business. The goal sounds simple: Take what you love doing, whether it’s baking gourmet cupcakes or crafting handmade jewelry, and turn it into a profitable business. You’ve seen others do it, so shouldn’t you be able to turn your dreams into money? The answer to that question, and the associated tax implications, is trickier than it appears.

How much do I pay myself?

You’ve earned some revenue from your business, but now you have to decide how to pay yourself so that you can put food on the table. You also have to take into account the various business expenses associated with your small business. Here are some things to consider:

  1. Look at the numbers to understand where the business money needs to be spent. Also, take some basic bookkeeping or accounting classes to have an idea of how to track your business’ success.
  2. Consider long-term goals: Will you need cash reserves to expand in the future? Will your costs increase?
  3. Plan ahead for tax-burdens: Meet with a tax expert to determine the best way to structure your business to avoid paying too much tax or too little.
  4. Be Consistent: Try to pay yourself on a regular basis and a set amount. Nothing causes more stress than running into cash flow problems that are created because you took out too much money the previous month.

With those thoughts in mind, the real question is: How do you know how much to pay yourself? The answer is that it should be “reasonable.” The IRS has certain amounts they consider reasonable, as do banks and financing companies. You must take into account the type of work you are doing, what others who do the same work are paid, how big your business is, and where your business is located. Your pay should be in-line with others in your area offering the same goods or services.

What type of business entity do I setup?

The type of business entity you setup determines how you are paid and your tax exposure:

  1. If you are a sole-proprietor, or a partner, you will typically pay yourself through a draw or distribution, and the income from the business will flow through to your personal tax return.
  2. If your business is a corporation (C-Corp, S-Corp, LLC) and you are considered an employee, you should be taking a reasonable salary and withholding taxes. You will receive a W2 at the end of the year to report your income.
  3. If your business is a corporation and you are considered an employee and an officer, you have more flexibility: For S-corporations, you would typically take a reasonable salary, then take a draw, dividend, or distribution, perhaps at the end of the year, or on a regular basis. The distributions will not be taxed at the corporate level as the income passes through to you personally.

You can also pay yourself in perks and benefits if you extend those benefits to your employees. The most typical options are health care plans and retirement and investment plans.

Don’t treat the business as your own personal piggy bank!

Unless you are a sole proprietor, one thing to avoid is the temptation to use the business accounts as your personal expense accounts. Your business is a separate legal entity and certain formalities must be maintained to keep the protections of the business. Paying personal expenses out of company accounts is prohibited by the IRS and can lead to audits and adjustments to your tax bill.