John is a clinical research site owner in Salt Lake City. His clinic has two full-time employees and five contract employees. The clinic has been open for a year and has generated $500,000 in revenue. John is considering owner payouts instead of W-2 payments for himself and his wife.
John, welcome to the show. How can I help?
Hey, Dave. Thanks for taking my call. I'm a clinical research site owner in Salt Lake City. I have two full-time employees and five contract employees. We've been open for about a year now, and we've generated about $500,000 in revenue. My question is about how to pay myself as the business owner.
I'm considering owner payouts instead of W-2 payments for myself and my wife. What are your thoughts on this?
The tax implications are the same for both options. If you take an owner payout, it's subject to self-employment tax, which is 15.3%. If you take a W-2 payment, you and your employer each contribute 7.65% to Social Security and Medicare.
So, the total tax implication is the same either way. The only difference is how it's reported on your tax return.
For me personally, when I was making $300,000 to $400,000 annually, I set my salary at $100,000 because that's what I needed to live on. The rest of the money was taken out as an owner distribution.
This strategy allowed me to save on self-employment taxes while still paying myself a reasonable salary.
That makes sense. Thank you for explaining it.
I appreciate your help.
Congratulations on your success with the clinic.
Financial Details of John's Clinic
Let's break down the numbers for John's clinic.
He mentioned that he had zero revenue until January and has generated $500,000 since then. So, he's made $500,000 over nine months.
If we assume that he has no expenses (which isn't realistic), his net profit would be $500,000 over nine months or approximately $55,555 per month.
If we multiply that by 12 months, we get an annual net profit of approximately $75,000.
So based on these numbers, I would set up W-2 payments based on the current net profit of $75,000 annually.
Long-Term Financial Planning Advice from Dave
As the business grows and cash flow becomes more predictable, I recommend setting up a more structured payment system with regular W-2 payments and a year-end bonus based on the company's performance.
This approach allows you to take advantage of tax savings while still ensuring that you receive a fair compensation for your work.
It's important to note that LLCs and sub-S corporations must pay taxes on the whole net profit annually regardless of how it's taken out. So if you don't need all of it for the business, you can take out excess profits a couple of times a year without any issues.
Just remember that retained earnings are subject to taxes if not reinvested by December 31 in an LLC or sub-S corporation.