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As the holiday season approaches, many small-business owners may find themselves weighing whether or not to pay their employees a bonus. If your business can afford it, there are a number of benefits to paying deserving employees a little something to show your appreciation for their efforts.
In addition to the subject of employee bonuses, entrepreneurs should also be asking themselves the question, "Should I pay myself a bonus?" If your firm has enough cash on hand, and enough savings in reserve, to fund a bonus for yourself then you should certainly consider taking one.
If you decide that you can afford to take a bonus, you need to be aware of the tax consequences before determining how much to pay yourself and when to take that distribution (e.g. this year versus next year, all at once versus in several smaller chunks).
Tax issues on bonuses for small-business owners can get pretty complicated, and you should speak with a tax professional about the consequences before paying any bonuses, but there are some basics to be aware of:
If you are the owner of an S corp or a C corp, all bonuses are treated as wages, meaning that you’ll be expected to pay federal, state and medicare taxes, as well as the Social Security tax if you haven’t already received the year’s maximum Social Security wages ($132,900 as of Jan 1, 2019).
If you are a C corp owner and you’ve already reached the Social Security limit, then a bonus could make sense. If you haven’t reached the limit, or you own an S corp, then a profit distribution instead of a bonus could be more advantageous. If you have a partnership or an LLC, the calculations can be more involved. Talk to your tax advisor to find out which works better for your situation.
You will, of course, also want to analyze the tax consequences of paying yourself a bonus versus retaining profits within the company and having them subject to corporate taxation. When it makes more financial sense to take a bonus, some business owners may be tempted to pay themselves especially large sums in order to lower their corporate tax burden.
Beware of this strategy.
If the IRS determines that you are paying yourself excessive compensation in order to lower your corporate tax liability, they can disallow the deduction of the bonus as an expense, in addition to charging you penalty fees and interest.
If you are running low on cash at the end of the year, as some businesses do, you might also be tempted to increase the use of a corporate credit card and/or delay paying some bills until next year in order to be able to pay yourself a bonus. In addition to being a potentially unsound business decision, this can also get you into trouble with the IRS who may view this as a sham transaction, since the funds to pay yourself were not readily available in liquid form. It is probably best stick to cash on hand when determining the size of your bonus pool.
Whatever legal form you have chosen for your company, make sure to discuss your bonus plans with your tax advisor, and possibly your attorney as well, to ensure that you are maximizing the use of your profits while staying in compliance with all tax laws.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.