How to Save $15,000 Per Year by Fixing How your Business Pays YouSep 07, 2023
One key area that every business owner should pay close attention to is taxes. The way you handle payroll and your family's involvement in your business can significantly impact your tax bill.
Why It All Matters
Let's start by understanding why all of this matters. As a small business owner, you're not just responsible for your company's success but also for managing your finances efficiently. Taxes can take a significant chunk out of your earnings, and if you're not careful, you might end up paying more than necessary.
For many small business owners, self-employment tax can be a significant burden. It covers Social Security and Medicare taxes, which are typically withheld by employers for their employees. However, when you're both the boss and the employee, you're on the hook for both portions. Understanding how to optimize your payroll and family's involvement can help you minimize these taxes and potentially save thousands of dollars each year.
Paying yourself as a business owner can be tricky. Some entrepreneurs make the mistake of taking too much or too little from their business accounts. Both scenarios can have adverse tax implications. For example, taking too much can lead to higher self-employment tax, while taking too little might not reflect your actual earnings. The general rule is to pay yourself 1/3 of your profit.
Paying Family Members
Many small business owners involve their family members in their enterprises. While this can be a fantastic way to keep the business in the family, it's important to note that paying your spouse is typically not recommended.
However, there are still opportunities to leverage the tax advantages of family involvement. For instance, paying your children can help you shift income to lower tax brackets.
Paying your minor children can be a tax-saving strategy. It's essential to keep their earnings below the standard deduction to avoid income tax. One option is to invest their earnings in a Roth IRA, setting them up for a secure financial future.
This approach allows you to reduce your taxable income while teaching your children valuable financial lessons. Just remember to follow the rules and keep everything above board.
Payroll for Small Businesses
Choosing the right entity structure for your small business can significantly impact your payroll strategy. Common structures include LLCs, S Corporations, and partnerships. Among these, S Corporations are often favored for their flexibility and tax advantages.
In S Corporations, you can split your income into two components: salary and distributions. The 1/3 rule can help determine your reasonable compensation. By adhering to this rule and paying yourself a reasonable salary, you can minimize self-employment tax while still enjoying the benefits of your business's profits.
Setting It Up Legitimately
Now that you understand the importance of payroll and family involvement in your small business, it's time to set things up legitimately. Start by obtaining an Employer ID Number (EIN) from the IRS. This unique identifier will be essential for tax reporting.
For seamless payroll management, consider using a service like Gusto. It simplifies the process, automates tax filings, and ensures compliance with federal and state regulations.
Don't forget to check your state's specific requirements and accounts, as regulations can vary widely. Staying informed and organized will help you navigate the complexities of small business taxes with confidence.
Maximizing tax savings for small business owners isn't about cutting corners or bending the rules; it's about making informed decisions within the framework of the law. By understanding the nuances of payroll, family involvement, and tax strategies, you can keep more of your hard-earned money and invest it where it matters most – in the growth and success of your business. Remember, proper planning and compliance are your allies on the journey to financial success as a small business owner.
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