You have your very own private practice, and even paying clients – congratulations! You’re officially the owner of a business with revenue (and hopefully profit too!). How do you pay yourself out of your profits? Is that the best way? Can doing it differently save you money? Here are some ways practice owners pay themselves, their pros and cons, and which one is best for what situation.
As always, I’ll start with the caveat: I’m neither an attorney nor a tax professional. The following is based on my experience and is accurate to the best of my knowledge, but is intended for informational purposes only. Consult with your legal and tax professionals before deciding to adopt these for your practice.
How Do Practice Owners Pay Themselves?
Here are the most common ways.
1. The “Headache Special”
Any money coming into the practice (also known as your revenue) goes into your personal checking, you then use that same checking account (and your personal credit card) to pay all expenses, whether personal or business. No need to figure out how to pay yourself!
This is what I’d call the “let’s create a giant headache for myself and my accountant” method. You’ve just mixed your personal and business finances, so at tax time you’ll need to go through every purchase you made during the tax year, scratch your head, and try to decide if it was a legitimate business expense or if you just bought some home supplies at Target. How about cash withdrawals? Do you remember if you used some or all of it to pay for coffee and donuts for you and a colleague as you discussed business matters? If not, how will you know to deduct half of it? Now imagine if the IRS ever decides to audit you (*shudder*).
If I had a hobby with low enough profits to not be taxable, I might be lazy enough to do this. Well, not really (just read my confession below and you'll see how over-the-top I go with these things).
2. The “Separate but Unplanned”
Put your revenue into a business checking account, pay for business expenses from that (and a business credit card), and “pay yourself” whatever’s left at the end of the week or month by moving it to your personal checking account.
Now we’re starting to get quasi-reasonable. Here, you can mostly tell what expenses were for business without too many headaches. Assuming you wrote down somewhere what each credit card, check, or cash transaction paid for, your accountant may start liking you.
The drawback is that this makes covering your personal spending needs complicated. Some weeks or months you’ll have a lot of money left over, but other times you’ll find the business account nearly empty and have no money for personal stuff.
This is what I do with businesses that don’t make the bulk of my profits. I just assume for budgeting purposes that they won’t make money, so I don’t count on any regular “pay” from them. However, I’d never do this with a practice that pays my mortgage and other bills.
Ok, ok, if you twist my arm I'll spill the beans. I actually have a ginormous spreadsheet where I project all our revenues from each business (no matter how small), expenses for all those businesses, all personal expenses, investments, net worth, etc. five years out(!). I know, you got me. I'm a total numbers geek.
3. The “Planned but Unoptimized”
Put your revenue into a business checking account, use this account (and a business credit card) to pay for business expenses, cut yourself a paycheck weekly, biweekly, or monthly. Then, if there’s anything left over at the end of the quarter or year, celebrate with it (or put it into savings).
Now we’re talking! If you figured out in advance what your likely revenues and expenses will be, you could use that knowledge to establish a reasonable salary for yourself. One that you’re confident will never cause you to overdraw your business checking account, and which will let you create a personal budget (including repaying student loans or credit card debt; setting aside money for taxes; as well as saving for retirement, your kid’s college fund, down-payment on a house, etc.) Then, if there’s extra at the end of the quarter or year, you can go out on the town.
When my consulting practice was just starting out, this is what I did. At that point, profits weren’t much higher than a defensible salary, so tax savings from the next method wouldn’t have justified its extra cost and complexity.
4. The “Planned and Optimized”
Set up a formal payroll system where your practice pays you a salary into your personal checking. This salary is a business expense like your office rent. Take any remaining money (profit distributions) monthly or quarterly.
If your practice has enough profit, talk with your accountant and attorney about setting it up as a limited liability company (LLC) if that’s allowed in your state, and electing to have the IRS tax it as if it was an S-corp (here's some more details about business entities you can use). If your state doesn’t allow LLCs, consider a straight S-corp. With your accountant’s help, decide what level of salary would be defensible if the IRS started asking questions, and have your business pay you accordingly each pay period.
You’ll pay income tax and payroll taxes (Social Security and Medicare) on this salary, but any additional profits would be considered distributions subject only to income tax. Even better, if your profits are lower than the generous limits set in the 2017 tax law, you could deduct 20% of the profit distributions before paying taxes on that portion (verify the details with your accountant and/or read what my accountant vetted about how the new tax law affects therapy practices). These tax savings need to be significantly more than the added payroll and accounting costs.
This is what I currently do with my main consulting practice.
The more profit your practice brings in, the more you can and should plan and optimize your business structure to make your accountant’s life easier and your taxes lower.
If you have any questions on any of this, please enter them as a comment below. I promise to respond to such questions by posting my own comment. If you’re in my mailing list (you are, right?), I’ll even notify you by email once the answer is posted.