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Employee issues: How to pay yourself

Small Business BasicsBefore you decide how many hours and what type of benefits, if any, you can afford to give an employee, you need a compensation structure for yourself. You've put endless amounts of time, tears and cash into your business, so how do you start pulling something back out? Small business owners can compensate themselves in several ways. Many depend on how the business is structured. Each withdrawal must be weighed against the impact on the health of the business and taxes.

Here are a few ways to reward yourself for your work:

Bonuses -- This is an easy way for owners of sole proprietorships, partnerships or Limited Liability Corporations to pay themselves at year's end once profits have been totaled. They can be coupled with small "draws" during the year.

Dividends -- Profit distributions, or dividends, are exempt from self-employment tax, a big plus for S Corporations, which distribute money in two ways: wages and profit distributions. The owner can save approximately $1,530 for every $10,000 profit distribution.

Draw -- Unlike corporations, entities such as partnerships, LLCs or S corporations are taxed only once. All profits go to the owners, so you take wages, or a "draw," and report it on your personal return.

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Fringe benefits -- These extras can add up. Many of them are business deductions, and can include:

  • Company car, if applicable
  • Health insurance -- Deductible only for C corporations unless you employ a spouse, place him or her in an employee health plan and are covered as the spouse of an employee.
  • Life insurance -- Split plans can benefit owners and employees.
  • Paid vacations, holidays, sick days
  • Reimbursement accounts, such as medical and dependent care
  • Retirement plans -- A tax-exempt method to build up personal wealth from the business.

Income shifting -- Certain small business owners can shift income to a lower tax bracket and avoid some payroll taxes by employing family members. Income to children under age18 is not subject to Social Security withholding (FICA). Wages to those younger than 21 are not subject to unemployment insurance (FUTA). Income to children remained tax-free up to $4,250 in 1998. Wages you pay a spouse are subject to FICA, but not FUTA.

Straight salary -- This is important only in the double-taxation situation of the corporation whereby corporate tax rates are imposed on profits minus expenses, including salaries. Any profits left are distributed as dividends. You determine the size of the salary you take after weighing who gets the greater tax benefit of the salary deduction -- you or the corporation.


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