S-Corp owners: How do you deal with profits and pass-through tax obligations?

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S-Corp owners: How do you deal with profits and pass-through tax obligations?

Post by mrlan » Fri Jul 31, 2020 7:03 pm

Would like to hear from other S-Corp owners who anticipate higher-than-usual profits and the personal tax hit that follows. What do you do to either reduce the burden or mentally accept it?

My S-Corp is less than 10 years old. Home-based. Revenue slowly built to the level where I could pay myself a very small salary, but there was almost no profit. But sales were increasing. In TY 2018 my company had a $25k profit, which passed through to my personal return. While the modest business success felt great, the tax hit felt really bad. It didn't "feel" like our gross income was as high as our tax return stated; I only took out a $10k distribution (partially to pay the taxman) and left the rest in the company to reinvest. Another unwelcome aspect of this was the FAFSA impact, which made it look like we had more money coming in to the household.

In TY 2019 I bumped up my salary, started paying my DW a small salary (she was already doing work for free in the evening after her FT job) and opened a solo 401k and started contributing to it. Expenses started going up along with sales. There was a small profit for the S-Corp and actually a big tax refund because in TY 2019 I was paying huge quarterly estimated taxes based on what happened in TY2018. So we got back most of that.

This year (2020) my business has been going really well. I am thankful especially in the era of COVID. But I am also worried. Profit could top $100k, even after increased expenses as well as salary bumps for both me and DW (Also hired teen child this summer to do inventory but that may not last when school starts back up). We are maxing out employer contributions to solo 401k, and are increasing employee contributions (carefully for DW; she also contributes to FT 401k pretty agressively). I've done a lot of upgrades of tech and office gear. With the increased salary, we have maxed out Roth contributions for the first time ever and are also putting more money in kids' 529s.

With the increased payroll taxes I and my company are paying, that will help with SS down the road (I am in my 50s, DW late 40s) but I haven't done the calculations on how much of a difference it will make.

So, in summary, the newfound sales for my company are great, but I feel not that great that I will end up paying a lot of taxes on "income" that I may not even really enjoy as I imagine most of it will stay in the company to cover COGS and marketing expenses. I don't want to expand the company too much (for instance, investing in a rented office/warehouse). I am a pessimist by nature and anticipate that sales may not be sustainable at this level, and even if they are, those sales may not be as profitable as expenses and competition grows.

So for fellow S-Corp owners who have gone through this (or alternating flush/lean periods) how do you deal with this on a practical level and mental level? General best practices, as well as specific advice would be appreciated. Thanks.

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Re: S-Corp owners: How do you deal with profits and pass-through tax obligations?

Post by mgensler » Fri Jul 31, 2020 8:46 pm

Well, you can get a line of credit from a bank to smooth out the lumpiness in cash flow or you can slow down/stop marketing. Yes, it's a challenge especially if you have a business with physical inventory or expensive equipment. We invested 30% of our profits before tax back into our business every year. So after taxes we only had around 20%-25% of the profit left in our personal account. However, the company grew 30% annually on average and we ended up selling it to a larger company.

Sounds like things are starting to take off for you. You're not going to get the reward without taking some risk. You don't have to go crazy, maybe target keeping your profit margins high and invest as much as you feel comfortable or as opportunity arises.

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Re: S-Corp owners: How do you deal with profits and pass-through tax obligations?

Post by MarkerFM » Sat Aug 01, 2020 8:20 am

When I owned S-Corps that generated large amounts of income (and cash), I paid some out as salary, had generous benefits, and basically distributed the rest. The distributions didn't necessarily always match the taxable income, but they were close.

I used a line of credit and bank loans to finance growth, and paying them off was not really a burden. The line of credit was used to fund organic growth, and loans were used to fund acquisitions.

I was happy when I sold them at a great valuation and during a time when the capital gains rate was low. Nice to convert that max-tax income stream to something I could manage the taxes on.

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