10 Really Expensive Tax Mistakes That Business Owners Make

Charles Zagara, JD, CTC

10 Really Expensive Tax Mistakes that Business Owners Make

 Mistake number one.  They pay themselves too much money.  WHAT?  They get paid too much money?  How can they get paid too much money?  They work hard.  They work long hours.  They work weekends.  They work holidays.

 I hear all of that.  Let's understand that there are many ways to be compensated when you own a business.  Of all the ways to be compensated, a paycheck is the most inefficient way from a tax standpoint.  Wages and salaries are layered with taxes.  You pay federal income tax, federal social security tax and  federal medicare tax.  Your business pays federal social security tax and federal medicare tax, you also pay state income tax and in many places you pay local income tax.  You pay these taxes right away, so it is an immediate drain on cash flow.  Crippling penalties kick in for failing to timely pay these taxes.  In Ohio, where I am from you not only pay local income tax where you work but also where you live.  Also salaries and wages are subject to other payroll related taxes such as unemployment and workers' compensation. Layers and layers of taxes.

The key is to have as low as salary as possible but high enough to satisfy the IRS.  The Feds  require you to take reasonable compensation from your business.  How much is that.  Well, there is no set number.  It is based on the facts and circumstances.  An experienced tax attorney or accountant should be able to take you through the different factors and help you establish that number.

 Don't let your ego get in the way of effective tax planning.  I was talking to a prospective client in Las Vegas.  She and her husband were doing very well during the Vegas building boom.  They were in the stucco business.  Together they were taking $400,000 of salary out of the company.  When I suggested to her that their pay was too high, she became very indignant and told me that she and her husband were worth every penny.  She stated they were both well educated, had post graduate degrees from prestigious universities and they and were working very hard.  I told her I didn't doubt they were worth it, but there were better ways to reward themselves.  She just could not wrap her head around it.  I'm sure when the crash hit she wishes she had those unnecessary tax payments tucked away some place.

One of the cornerstones of proactive tax planning is to efficiently use the laws to the taxpayer's advantage as opposed to the government's advantage.  First and foremost is structuring your compensation.

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