"The Balance Between Your Corporation and Your Salary"
By Kenneth Cerini, CPA, CFP, DABFA
For years S-Corporation owners have utilized shareholder distributions as a way of pulling profits out of their business. Too often, however these distributions came in lieu of salary.
Taxation of Distributions:
S-Corporations provide their shareholders with the benefit of a single layer of tax. They are pass through entities, so any earnings of the corporation pass through the corporation to the individual shareholders where they are ultimately taxed. As a result, the shareholders personally pay tax on the profits whether they are distributed or not. Therefore, distributing these profits does not provide for any additional taxation. This differs from a regular or C-Corporation, in that the C-Corporation is not a pass through entity. Profits, therefore, are taxed at the corporate level and not the individual level. When profits are ultimately distributed to shareholders, they are transferred as dividends, subject to tax at the personal level … double taxation. As part of the 2003 Economic Growth and Tax Recovery Act, the tax on dividends was lowered to 15% and 10% (dependent on income levels), however there still remains two levels of taxation.
Taxation of Wages:
The taxation of wages is substantially the same whether an entity is an S-Corporation or a C-Corporation. The corporation gets a deduction for the wages paid, providing such wages are reasonable, and the shareholder receiving the wages is taxed individually for those wages. In a C-Corporation this effectively eliminates the double taxation because the income is transferred from the corporation to the individual shareholder. This is not the case in an S-Corporation however, since the S-Corporation has only 1 level of taxation.
In addition, wages are subject to other forms of taxation, namely Social Security, Medicare, workers' compensation, and Federal and state unemployment. This could result in additional taxation of some 20% or so.
Distributions in Lieu of Wages:
As a result, shareholders generally benefit from having monies paid to them in the form of distributions as opposed to wages. While this is not in compliance with IRS regulations, many small corporations, nonetheless, have employed this strategy over the years. The IRS has always maintained its ability to recharacterize S-Corporation distributions to wages, when they believe that wages paid to shareholders are too low. And in fact, court cases have supported the IRS' position of recharacterization. In the past, however, it was not a high priority for the IRS, so the practice went unchecked.
The IRS' Renewed Interest:
The IRS believes that this practice has gone on too long, and they have recently expressed an interest in challenging such cases in the future. Where a shareholder provides services to an S-Corporation, and such services are instrumental in the corporation's operations and profitability, the IRS will be looking to see that the individual received reasonable compensation for such services. If the shareholder did not, and the shareholder received distributions of profits, the IRS will consider challenging the status of these distributions in an effort to reclassify them as salary.
During 2002, the IRS performed a study, whereby 84 S-Corporation cases were "judgementally selected" from a population of returns where income exceeded $50,000, but compensation to officers was below $10,000. The results were staggering. Average shareholder compensation was $5,300 while average distributions to shareholders were $349,323. The large disparity between these amounts suggests a potential underreporting of salaries.
Conclusion:
In order to avoid the taxes, penalties, and interest associated with a recharacterization of distributions to wages by the IRS, it is going to be imperative for S-Corporation shareholders to pay themselves reasonable compensation before any distributions are taken. The issue is going to come down to exactly what is reasonable compensation, and how is it determined. The goal will be for shareholders to find an amount they can live with and that will also appease the IRS.
Kenneth Cerini, CPA, CFP, DABFA is the Managing Partner of Cerini & Associates, LLP, a full-service accounting and consulting firm located in Suffolk County, NY. The firm specializes in providing in-depth business advisory services to small business and non-profit organizations. For additional information visit them on the web at www.ceriniandassociates.com.
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"Look Before You Leap ... Is A Home-Based Business REALLY For You?"
© 2000 Elena Fawkner
Working from home sounds wonderful, doesn't it? No commute; no boss breathing down your neck; no fixed schedule; reward for effort; control; work/family flexibility; not having to worry about being laid off; leaving the office politics way behind; not having to get dressed up; being with your children. Is this what comes to mind when you think about what it would be like to work from home? If so, take a good hard look before you make the jump from paid to self- employment.
Although these are all indisputably strong benefits of running your own home-based business, they need to be weighed against some pretty harsh realities if you are to make an informed decision whether a home-based business is truly right for you. These realities can be grouped into three main areas: personal, financial and situational.
PERSONAL REALITIES
-> Commitment - you must be totally committed to making a success of your business. It is important to distinguish between commitment and mere interest. If what you want to do as a business is only an interest, your enthusiasm and motivation may wane over time. You must be absolutely committed to the success of your business if you are to achieve the success you desire.
-> Risk-Taker - one of the benefits of owning your own business is that you don't have to answer to a boss. The other side of the coin is that there is no-one to fall back on if things go wrong. If you make a mistake or suffer a loss, you wear it. For this reason, you must be comfortable taking calculated risks. If security and stability are very important to you, perhaps paid employment is a better option.
-> Self Motivation - again, there is no boss to wave a carrot under your nose to get you moving. You must be able to motivate yourself to do what needs to be done and that includes the stuff you don't particularly enjoy doing.
-> Self Discipline - being your own boss means exercising personal discipline to ensure that the work gets done. There will be no end of distractions to tempt you away from the task at hand when you're working from home. You will need a healthy dose of self discipline to ensure you stay on track.
-> Patience - starting a home-business is one thing; turning a profit is quite another. You will not make a profit overnight. Be prepared to be patient and frugal during the first few months of your new venture.
-> Reasons - closely related to the need for self-motivation, your reasons for wanting to work from home will keep you in the saddle. If your reasons are to get rich quick or work fewer hours, think again. A home-based business will definitely not deliver.
-> Flexibility and Adaptability - you may have come from a corporate environment where you enjoyed a certain status. You may have had a secretary or assistant to take care of the more routine aspects of your job description. In your home-based business you will need to be prepared to wear many hats, at least in the beginning. This means being flexible and adaptable, being prepared to learn new skills and willing to take on new tasks.
-> Willingness to Sacrifice - especially in the early stages of your business, be prepared to make sacrifices in terms of time and money to get your business off the ground. You will need to be prepared to put in long hours and, more likely than not, get by on less money than you were bringing home from your paid job.
-> Work Ethic - the backbone of all of the disciplines you will need to practice in your home business is your work ethic. If you have a strong work ethic then the need for personal discipline and sacrifice will come as no surprise.
-> Stress Management - the burden of your business's success or failure will rest squarely on your shoulders. That's a lot of responsibility. Consider your capacity for stress management. If it's not high, learn ways to increase it.
FINANCIAL REALITIES
-> Cash Reserves - if business is slow to start, do you have sufficient cash reserves to see you through? If not, perhaps you should consider starting your business part-time until it is bringing in enough of a profit to sustain you.
-> Retirement Planning - say goodbye to the employer-sponsored pension plan and hello to the world of IRAs (Individual Retirement Accounts). You need to think differently about your retirement plans and should seek the advice of a qualified financial planner in the early days of your new business.
-> Health Insurance - say goodbye too to the perks of paid employment such as free medical, dental, life and disability insurance. You will need to take out your own cover for these risks.
-> Vacation - no-one's going to pay you while you take that two week vacation any more. And, while we're at it, who's going to run your business while you're away?
SITUATIONAL REALITIES
-> Hard Work, Long Hours - if you think that working for yourself means you won't have to work as hard or as long, think again. Most likely it will mean more of both.
-> Interruptions - if you have children at home, be prepared for constant interruptions. Being with your children, of course, is one of the main advantages of working from home but you will need to set limits if your business is to get sufficient attention. The same goes for your spouse!
-> Distractions - beware of the temptation to take care of household tasks during the time you have allocated to your business. It's very tempting to run a load of washing or vacuum the carpets instead of facing up to that business task you don't feel like doing right now. Self-discipline is crucial if you are to avoid procrastination undermining your productivity.
-> Isolation and Loneliness - if you come from a busy corporate background, at some point after the novelty of working from home begins to wear off, you may begin to feel isolated and even lonely. Be prepared with strategies to keep the isolation blues at bay. See "Overcoming Isolation in Your Home Business" at Overcoming Isolation for some suggestions.
As you can see, although there are many wonderful reasons to work from home, there are also many strong reasons why a home-based business may not be the right choice for you. Take a good hard look at the above realities and your own personal qualities and motivations. Do you have what it takes to make a success of your business? Are you prepared to do what has to be done? Whatever that is? If so, a home-based business may very well be just what the doctor ordered. But, if you have any doubts, look very hard before you make the leap from paid employment to your own home- based business. You could very well be jumping from the frying pan into the fire.
Elena Fawkner is editor of A Home-Based Business Online ... practical ideas, resources and strategies for your home-based or online business. AHBBO
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"10 Secrets of Successful Entrepreneurs"
by Jenny Fulbright
Running a one-person business is a creative, flexible and
challenging way to become your own boss and chart your own
future. It is about creating a life, as it is about making a
living. It takes courage, determination and foresight to decide
to become an entrepreneur. From the relatively safe cocoon of
the corporate world, where paychecks arrive regularly, you will
be venturing into the unchartered territories of business.
Is there a way to determine whether you can be a successful
entrepreneur, or you are better off to work for somebody else?
Alas, there is no formula for success. However, most successful
entrepreneurs share these ten characteristics. Check if you
possess any one of them:
1. Think success. To attain the kind of success that you want,
you need to dream big. Every success story starts with big
dreams. You need to have big dreams for yourself - which you
want to be somebody rich, famous or fulfilled. You need to have
a clear vision of what you want to achieve. But it doesn't stop
in dreaming alone. You should actively visualize success in your
mind that you can almost feel it, touch it or it is within your
reach. Play this image back at every opportunity. What does it
feel to triple your current income? How will your life change?
What will your business look like if you achieved the
million-dollar mark?
Successful entrepreneurs possess an attitude of openness and
faith that you can have what you want if you can simply envision
it as the first step on the path of action to acquiring it.
Management gurus have taught us the power of visualization -
seeing yourself in your mind as having accomplished your dreams.
If you want to be a successful writer, envision yourself signing
books for a throng of people who have lined up to have your
autograph. If you want to be rich, picture yourself in luxurious
surroundings holding a fat bank account. And the process of
envisioning success for you should be a constant activity! You
need to think that you are successful (or will be one) every
single waking hour. A personal development coach shared me her
secret to help her continuously visualize her goals for the
moment: when climbing stairs, recite your goal with every step
you take. So if you want more money, say "I will have money" in
every step of the stairs. This technique will reinforce your
goal and keep it fresh in your consciousness.
2. Be passionate with what you do. You start a business to
change any or all part of your life. To attain this change, you
need to develop or uncover an intense, personal passion to
change the way things are and to live life to the fullest.
Success comes easily if you love what you do. Why? Because we
are more relentless in our pursuit of goals about things that we
love. If you hate your job right now, do you think you will ever
be successful at it? Not in a million years! You may plod along,
even become competent at the tasks, but you will never be a
great success at it. You will achieve peak performance and do
what you have to do to succeed only if you are doing something
that interests you or something that you care about.
Entrepreneurs who succeed do not mind the fact that they are
putting in 15 or 18 hours a day to their business because they
absolutely love what they do. Success in business is all about
patience and hard work, which can only be attained if you are
passionate and crazy with your tasks and activities.
3. Focus on your strengths. Let's face it; you cannot be
everything to everybody. Each of us has our own strengths and
weaknesses. To be effective, you need to identify your strengths
and concentrate on it. You will become more successful if you
are able to channel your efforts to areas that you do best. In
business, for example, if you know you have good marketing
instincts, then harness this strength and make full use of it.
Seek help or assistance in areas that you may be poor at, such
as accounting or bookkeeping. To transform your weakness to
strength, consider taking hands-on learning or formal training.
4. Never consider the possibility of failure. Ayn Rand, in her
novel The Fountainhead, wrote, "It is not in the nature of man -
nor of any living entity, to start out by giving up." As an
entrepreneur, you need to fully believe in your goals, and that
you can do it. Think that what you are doing will contribute to
the betterment of your environment and your personal self. You
should have a strong faith in your idea, your capabilities and
yourself. You must believe beyond a shadow of a doubt that you
have the ability to recognize and fulfill them. The more you can
develop faith in your ability to achieve your goals, the more
rapidly you can attain it. However, your confidence should be
balanced with calculated risks that you need to take to achieve
greater rewards. Successful entrepreneurs are those who analyze
and minimize risk in the pursuit of profit. As they always say,
"no guts, no glory."
5. Plan accordingly. You have a vision, and you have enough
faith in yourself to believe that you can achieve your vision.
But do you know how to get to your vision? To achieve your
vision, you need to have concrete goals that will provide the
stepping-stone towards your ultimate vision. Put your goals in
writing; not doing so just makes them as intangible fantasies.
You need to plan each day in such a way that your every action
contributes to the attainment of your vision. Do you foresee
yourself as the next Martha Stewart of hand-made home
furnishings? Perhaps today, you need to see an artist to help
you conceptualize the new line of hand-made linens that you hope
to launch. Intense goal orientation is the characteristic of
every successful entrepreneur. They have a vision, and they know
how to get there. Your ability to set goals and make plans for
your accomplishment is the skill required to succeed. Plan, plan
and plan - because without which failure is guaranteed.
6. Work hard! Every successful entrepreneur works hard, hard and
hard. No one achieves success just by sitting and staring at the
wall every single day. Brian Tracy puts it out this way, "You
work eight hours per day for survival; everything over eight
hours per day is for success." Ask any successful businessperson
and they will tell you immediately that they had to work more
than 60 hours per week at the start of their businesses. Be
prepared to say goodbye to after-office drinks every day, or a
regular weekend get-away trip. If you are in a start-up phase,
you will have to breathe, eat and drink your business until it
can stand on its own. Working hard will be easy if you have a
vision, clear goals, and are passionate with what you do.
7. Constantly Look for Ways to Network. In business, you are
judged by the company you keep - from your management team,
board of directors, and strategic partners. Businesses always
need assistance, more so small businesses. Maybe the lady you
met in a trade association meeting can help you secure funding,
or the gentleman at a conference can provide you with management
advise. It is important to form alliances with people who can
help you, and whom you can help in return. To succeed in
business, you need to possess good networking skills and always
be alert to opportunities to expand your contacts.
8. Willingness to Learn. You do not need to be a MBA degree
holder or PhD graduate to succeed in your own business. In fact,
there are a lot of entrepreneurs who did not even finish
secondary education. Studies show that most self-made
millionaires have average intelligence. Nonetheless, these
people reached their full potentials achieved their financial
and personal goals in business because they are willing to
learn. To succeed, you must be willing to ask questions, remain
curious, interested and open to new knowledge. This willingness
to learn becomes more crucial given the rapid changes in
technologies and ways of doing business.
9. Persevere and have faith. No one said that the road to
success is easy. Despite your good intentions and hard work,
sometimes you will fail. Some successful entrepreneurs suffered
setbacks and resounding defeats, even bankruptcy, yet managed to
quickly stand up to make it big in their fields. Your courage to
persist in the face of adversity and ability to bounce back
after a temporary disappointment will assure your success. You
must learn to pick yourself up and start all over again. Your
persistence is the measure of the belief in yourself. Remember,
if you persevere, nothing can stop you.
10. Discipline yourself. Thomas Huxley once said, "Do what you
should do, when you should do it, whether you like it or not."
Self-discipline is the key to success. The strength of will to
force yourself to pay the price of success - doing what others
don't like to do, going the extra mile, fighting and winning the
lonely battle with yourself.
About the author:
Jenny Fulbright is a Staff Writer for PowerHomeBiz.com. For
information on starting a small and home-based business, visit
PowerHomeBiz.com
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