What Is the Proper Way to Pay Yourself As the Owner of an LLC | Ask Clay Anything

Audio Transcription

You have questions. America’s number one business coach has answers. It’s your brought up from Minnesota. Here’s another edition of ask clay, anything on the thrive time business coach radio show.

[Inaudible].

All right. Thrive nation. On today’s show we’re having a conversation with an anonymous member of the thrive nation. Mr anonymous, how are you sir? How are you? I’m doing well now. We had a meeting this week and in the meeting you were asking me about taxes and we ran out of a little bit of time there. So I wanted to call you and answer your question. So can you kind of tee up your question again and I won’t mention any part of your identity.

Okay. So we are a partnership and my partner and I have yet to be paid for five months now. We’re just doing our own thing on the side. Make money. But yeah,

Started from the bottom. Now you’re here. There you are.

Yeah, we’re getting there. We’re getting there. And so we’re wanting to see how we exactly go about paying ourselves a tax wise and a partnership LLC.

Okay. So I’m going to walk you through this. And there will be every time I give you advice, there will be somebody who is going to push back and say that what I’m telling you is wrong. So first off, what I want to do is I want to commit to being on one side of the, you know, like there’s discussions where there’s like liberals and conservatives. I am the most conservative tax guy you’re probably going to talk to. Okay? So so that’s where I’m going to go there every time. So, but there is one book I’d recommend for you to know about. It’s called small business taxes for dummies and I’m putting a link to it on the show notes so it can walk you through this. But here are the steps. All right? So step number one, you want to make sure that every time you pay yourself, you pay yourself as an employee, okay?

Up to an amount of what is called fair and reasonable. Okay? Superior self has an employee up to fair and reasonable. So let’s do an example. Let’s say hypothetically that a, you owned a taco truck. Alright. And then let’s say another listener out there owns a basketball coaching facility and somebody else out there owns a piano teaching class. And then Andrew, let’s say you own a full package media. Got it. All right. If you looked at the average income of somebody who owns a basketball lesson facility, right in America and the average, what that person would get paid if they ran a real estate photography company and the average of whatever your industry is, that is what you should pay yourself in, in income employee income. Like that’s the most you should pay yourself as an employee. Does that first part make sense? It does.

So if it would be unreasonable, if, let’s say the IRS were to audit your business because the IRS, their job is to make sure whether we like it or not, that they collect taxes so we can, for roads, you know, defense, you are in the military, so you get it, you know, there’s money that has to come in and so they reach out to the IRS. Typically in your mind, audit individuals or businesses? Businesses for sure. Because you’re more likely to have more money. I mean, I mean, Andrew, do you know how many guys who are employees who have employees who work for them while they work at their job? Right? So they’re not going to audit a lot of employees. So they’re going to audit the cause. The employees have their income already taken, taken out, right? So if you have a business, mr whoever you are, and if you have no income, no, no employee income tax going out for the owner of the company, it looks weird, right?

Yeah. So step two is you want to avoid red flags. All right? So you want to avoid things that are just like, like if I walked into the building, covered in dog poop, and you said, man, who smells like dog poop? Would it sort of be a giveaway that it might be me if I’m covered in head to toe and what appears to be dog poop? You know? So if the IRS looks across America and they know they know darn well that about 15 to 20% of Americans are trying to screw them over on taxes, that’s a real thing. And they look at the guy who’s hasn’t paid any taxes, who are they gonna say, ah, probably you probably don’t want to be right. So then what you want to do at that point is you want to make sure that you then pay yourself distributions.

And this is something your accountant can set up. So I’m just making up an example, but if you and whoever you are that you guys pay yourself, let’s say in your industry, the average person makes a salary of $40,000 per year average salary if that’s the average and you so between, so now you, now you’re pulling $80,000 between the two of you. So you’re each making four grand a month right? Up until that point, it should all be employee income tax. In my humble opinion, based on my 22 years being self employed, based on having been audited based on having worked with thousands of one-on-one business coach clients. You get the idea that would be my experience. Now after that, you can set up what’s called distributions and distributions are aware. A set percentage of the profits flow to you almost like dividends on a stock and you have to be set up the right way to do that.

And that’s where an accountant would help you and then you take distributions and those distributions are taxed at a lower rate. They should be if you’re doing equal work and are equal partners. Okay. Even if you’re not equal work, but you’re equal partners, typically you’re there taking the same, yes, I see. Now let’s say you open up another location of whatever it is that you do, whoever you are. So now you’ve opened up your second location of wherever it is, whoever you are in whatever city. And when you open up that that, that, that next one, let’s just say hypothetically, you never worked there at all because you had someone who ran it for you, right? Right. Then all of your income could be taken as distributions.

And is that tax exempt or is that

Not exempt? But it’s at a lower rate. Are you familiar with how much capital gains are taxed at right now? Are you familiar with this? Okay, this is good. Okay. So capital gains tax 2019 right now, I’m just looking at it right now. If you are making income off like stocks and bonds, you know, what do you think the maximum amount is that you would pay on your capital gains tax?

[Inaudible]

I, I couldn’t even tell you

The maximum is, again, this is just stuff to think about. Okay. There are different brackets, but yeah, most of it’s going to be between zero and 20%. Okay. Okay. That’s what I was thinking. Yeah. But your income tax, if you add in your federal and your state is higher than that, why? Because the government wants people to buy stocks, you know what I mean? Right. So why would they allow you to take distributions at less of a rate? Because they want you to own companies because you create jobs. So, but you don’t actually work in the day to day. I’m on the second location.

Hmm.

Makes sense. And then the third, the third, you could do the same thing and the fourth and the fifth and whatever. You know, that’s how it works now for Clark holdings. That’s me. You know, like for my distributions from a tip top canine, the company I work with to help franchise now the dog training business every time that they you know, every month when revenues come in I get a certain percentage of that revenue that goes back to me. Right. And it goes not to me as an employee. It goes as a, as a, as a distribution. And then I have to declare myself a salary that I pay myself and I do pay a lot in Texas. Is that helpful?

Makes sense. It does. Yeah.

Yeah, you answered it. So step one, two, three I got here for you is you want to pay yourself as an employee. Step one up to what is considered fair and reasonable, right step to avoid red flags. Just whenever you’re dealing with the IRS, there’s, there’s so many people that are scamming the IRS right now unnecessarily. We all need to pay our fair share. I do believe that. And whether you are Republican or Democrat, whether you want to build a wall or not, whether you’re four big military, small military, the point is we’re spending a lot of money as a country and we all need to pay our taxes. And if we don’t do it, the whole system falls apart. So that’s how that works. And then step three, we got to pay you know, your, you want to get paid as a distribution. So you want to get paid as you want to get paid. The remainder, your bonuses as distributions.

Nope, not when it comes to distributions. Are there a limited amount that you can take out monthly or annually

That’s going to be the work of an accountant that would sit down with you and would guide you based upon what’s fair and reasonable. And because I know your industry very well, I know that very few people in your industry make more than $4,000 a month.

Right?

And then they all take a ton of cash. Am I correct?

That’s correct.

Oh, it’s a cash business. So you’ve got a bunch of these people driving like Suburbans that costs what, 700 a month and they’re reporting income of 2000 a month.

Yup.

Yeah. These fancy people with their high interest rate cars cause they’re putting down, you know, five grand of cash and they’re running around with their cash everywhere. I mean, your, your business, is it not notorious for cash?

It is, it is all under the table.

And because the businesses in your industry, I mean, how often do you see people change t-shirts, change locations, change, company names, hop from city to city? I mean, how much all the time. Yeah. So, so you’re the big guys in the industry. So like elephant in the room, we’re the guys in the hair business that have it figured out, you know, and your business, you’re the guys in the whatever industry that had it figured out. And let me tell you what, if you’re the guys with the legit website and the most reviews and the best videos and the best print pieces and the best everything and the biggest, best, no brainer if you’re, if you’re the best, right? Ah, if you’re the IRS, what’s the one company whose door you would knock on if you’re the best? I mean, I’m not going to go try to collect taxes from the guy who can, you know, can barely open the doors.

Right, right, right.

You know, you guys have a legit lobby, a legit system, a legit process. Some of the people in your industry, it looks like they’re opera there, right? Looks at their operating like a bomb shelter from Beirut. Like they reenacted a scene from Beirut or something. You know, they’ve got windows knocked out and really crazy lobbies and it’s just, it’s bad. It feels like they’re like, this is where we shot the Taliban ISIS video. You know, this is, it’s just like a weird, so you’re, you don’t want to get audited there. Do you have any other business coach questions about paying yourself and or taxes while we’re on the phone here?

I don’t think so. Clay, you a business coach covered it all.

Okay. Now we have a West Carter on today’s show as well, a little bit later here and a West, you know, he’s the attorney of choice for Joel Osteen’s. His, his, his, his law firm has represented Joel O’Steen winters and King pastor, TD Jakes, pastor Joyce Meyers, Craig Rochelle, do you have any legal questions for him? Cause this might save you $375 per question. Do you have any legal questions? Just hot and fresh so I can ask Western our next segment.

I just might actually, yeah. Now, now when it comes to a business and a N like an S Corp owning the business yep. Legally wise are, are, are we held accountable for any things that happens to that, to that business on the top, within the escort? Is it,

So you’re wanting to know if you have an S Corp, what type of, Andrew put this on the very top of the show notes. What type of liability exposure comes with an S Corp? Is that we’re saying?

Yes. So like if we own our business through an escorp, what liability are we held under? Yeah.

Okay. So that is, okay. So, so again, I’ll make sure we put that on the show notes and we’ll ask West Carter in less than probably 30 minutes from now, and then I’ll send you that recording as well. Okay. Sound great. Alright, fantastic. You’re a great American, and I talked to your dad today. He says, hello. I appreciate it. All right, goodbye, whoever you are. All right. Three, two, one, boom.