If you’re a Profit First business, you get to take profit distributions four times a year. It’s exciting to see the fruits of your efforts and be able to boost your income as the business owner.
It’s honestly the best thing about Profit First, that you’re not limited by your owner’s pay (though it is important to pay yourself a living wage!). You get quarterly “bonuses” that you can spend as you wish.
You might ask, why not pay yourself more each week or month and enjoy the extra income in the moment…so you don’t have to wait until the end of the quarter? Because your profit distribution is not part of your salary. Even though it might look that way on your taxes.
Profit Distribution 101
One of the big misconceptions around profit distributions is that it’s part of the business owner’s salary. While yes, you get to take profits as the owner, the profit distribution you take at the end of every quarter is not part of your salary. Profit distribution and owner’s compensation are not the same thing.
Your owner’s compensation is payment for the work you do in the business.
Profit distribution is the reward you collect for owning the business.
This is why it’s so important to pay yourself a living wage. Your salary should cover ongoing living expenses, whatever it takes to run your household. Your salary is something that you should depend on, just like if you were going into a job where you’re an employee.
You should never depend on profit to pay your regular bills. Because if for some reason you didn’t have the profit you expected in a given quarter, you’d be left in trouble.
I want you to think of your profit distribution as a bonus and really have fun with it. You can also use your profit to create a sinking fund for vacation, since in many service-based businesses the company doesn’t make as much revenue when the owner is on vacation.
As with anything tax-related, the implications of your profit distribution depends on how you’re incorporated. One of the benefits of being an S Corp, if you qualify, is that while you’ll pay more taxes on Social Security and Medicare, you won’t pay taxes on your distributions.
And supporting our stance that owners should pay themselves a living wage, the IRS also requires that S Corp owners may themselves a reasonable salary. You can read more about this directly from the IRS here or a more user-friendly article here.
But basically, pay yourself what you’d expect to earn in a similar position as an employee.
If your business is a different entity, you’ll want to find out what the tax implications are for you because they will vary depending on where you’re located and what your revenue is.
Like anything in business, it’s important to talk directly to a tax professional when it comes to determining your tax liability and the business structure that’s best for you, your business, and your goals. It’s important to educate yourself about managing taxes and even reducing your tax liability throughout the year.