Nancy J. Williamson is the founder and CEO of Williamson Advisors, as well a seasoned certified public accountant. She brings over two decades of expertise in aiding business owners and entrepreneurs.
Ratchet+Wrench spoke to Williamson to find out how auto shop owners—with shops that bill over $100K—should approach payroll solutions to maximize their profits.
As told to Ivan Rioja-Scott
As founder and CEO of an accounting firm that services the auto repair industry, I talk to many shop owners who believe hiring their significant owner (“S.O.”) is a great way to reduce the taxes paid to the IRS.
Listen to me carefully—the most expensive way to pay taxes is to pay yourself and your family members W-2 wages. Let me state that another way: there are many ways that you can legally remove money from the company. Paying a W-2 wage pays the most tax to the IRS.
So, let’s review how to take funds from the company. We will focus primarily on the two most common entity structures: sole proprietorships (including LLCs that file as disallowed entities) and the famous S-Corp.
If your shop is organized as a sole proprietorship, you will pay yourself by removing money from the company and recording it as an owner draw. This works great until the business's net income reaches $100K (on average.). At that time, you should consider electing S-Corp status or forming a new entity that can be taxed as an S-Corp. This will save the self-employment taxes paid on your net income. If you currently employ your S.O. in the business, ensure that your S.O. receives health insurance and has access to any retirement plans in the company, but don’t pay them a W-2 salary.
Once you elect S-Corp status or if you are already organized as S-Corp, the owner must be paid a reasonable W-2 wage. The IRS requires this, and a particular line item on the S-Corp tax return shows how much is paid to the owner. Now, “reasonable” is subjective, and remember that paying yourself too much in W-2 wages will unnecessarily cost you. There are many ways to determine what is reasonable. Still, the bottom line is that you should consider paying yourself only what you would consider paying another employee to complete your job duties – and not a penny more. There are also reasonable compensation studies that can be completed to support the market wage that you are paying yourself. If your shop is profitable enough and you would like to pay yourself more, then take the money out as a shareholder distribution (like the sole proprietorship option.) Remember to make quarterly estimated tax payments because when you take a distribution, no taxes are paid to the IRS.
If your S.O. is currently working in the business, consider paying them enough to allow them to contribute to the company 401(k) plan fully. Many shop owners start offering a SEP (simple employee pension) or Simple plan because it is cheaper to implement. However, the benefits of the 401(k) plan far outweigh the administrative costs due to the much higher contribution limits allowed for each employee. Each employee can contribute $23,000 in 2024 towards a 401(k) plan and an additional $7,500 if the employee is over 50. The company and the employee pay social security and Medicare taxes on the wages paid and contributed. However, the savings from deducting the wages from the company’s net income should outweigh the cost of these self-employment taxes. If the company matches the 401(k) contributions of the employee, the S.O. will also receive this benefit. This option would allow the S.O. to take advantage of group life insurance plans, education assistance, and other benefits offered by the company. Further, if both spouses are employed, you may be able to take advantage of the childcare tax credit. The childcare tax credit requires both spouses to have compensation. On the downside, remember that you may have to pay workers’ compensation insurance on your S.O.’s salary.
In summary, hiring your significant other should be considered when your income and benefits in the business are maximized to create a win-win scenario. Please consult your tax advisor to ensure you legally minimize your tax liability before deciding.
Williamson Advisors is a national accounting firm that provides monthly accounting services, Profit First coaching, and tax preparation and tax strategies to the auto repair industry.
