The decisions you make today create what you own tomorrow. That's why you need to code your wages and know the differences between them. You want to create straight lines and clarity across all the players by making sure you're breaking down everything in your books.
We are going to dive into the officers compensation vs. shareholder compensation vs. wages & salaries. Knowing the difference is important. You want the tax return filed more efficiently and accurately because “reasonable compensation” is a big deal.
Being able to draw those lines and separate them out also allows you to analyze your business better. For instance, officers compensation and shareholders wages should not be reflected in your operation. And if you're a sole proprietor or a single-member LLC, you don’t get wages and salaries. Instead, you get an owner’s draw, which should not be part of your expenses.
This is actually very straightforward if you understand the hats you have on. States and federal agencies are ever more transparent now and all these things are going to tie down at some point. Therefore, you have to make sure that your processes around your finances and your partnerships are all on the same page.
If you're a sole proprietor, if you're an LLC as a single member, or you're an LLC as a husband and wife that did not adopt some kind of tax classification, you're still a single member, LLC.
You do need to understand the fact that in that structure, you don't get wages and salaries. There is no officer's compensation and there is no shareholder wages. You have owners draws and those owners draws should not be part of your expenses.
We want to be sure that you know that if you're growing this issue is probably going to knock on your door.
Shareholder vs officer’s compensation
A shareholder is different from an officer. A shareholder is the people that own the company that have invested in the company, they have ownership. They don't even necessarily have to work in the company and may not have wages at all.
An officer is someone that works and manages the company. Sometimes a shareholder will be an officer which is very common, especially if it's one person where they own a hundred percent of the shares or stock or interest.
So if you are a shareholder and an officer, then you have officer's compensation. You don't have officers compensation and shareholder wages, it's one or the other.
Here’s an example: You're an S-Corp, C-Corp or LLC taxes and S-Corp. You own 51% of the business, and are an officer and a shareholder, I own 49% as a shareholder. And I don't do anything except just collect my checks. Then we have a team. When you get paid as a wage inside the corporation, we're gonna make sure that that's being represented on our financials as officer's compensation and when you pay me a wage as a shareholder who does nothing but collect checks and benefits, that would go as shareholder wages.
You can also get benefits as an employee. When you're a shareholder working in the business or receiving benefits, you're an employee.
So where does your team's wages go? They will go to wages and salaries. This does not cover contract labor. Contract labor is not the same as wages and salaries.
You could be a sole proprietor or a single member LLC and decide to move into a S-Corp classification for tax purposes. There's a lot of cool stuff you can do as long as you do it the right way.
You should not rush into an S-Corp because if you don’t know how to take care of it, you shouldn’t be in an S-Corp. And if you make the wrong decisions at the wrong time, you're costing yourself money.
So if somebody tells you in a Facebook group to start an LLC and make it an S-Corp, you better run. Talk to someone that you trust, like your CPA, because there are things that you have to do and comply with.
If you want to learn more about officer’s compensation and shareholder compensation, check out Episode 098: Officers Compensation vs. Shareholder Compensation vs. Wages & Salaries.