One of the first steps in starting a small practice is forming a limited liability company (LLC). If you want to start a small side practice, you must form an LLC. It really is not optional due to the asset protections they afford. It also makes your business look legitimate and professional. I discuss how to set up a business here and more information specifically about the LLC here.
Two questions I see time and time again over on the Facebook groups are “How do I pay myself?” and “How do taxes work?” It is pretty straightforward. It depends on the structure of the LLC.
You can structure the LLC as a sole proprietorship, S-corporation, or C-corporation.
If you form an LLC and do not elect to be treated as an S-corp or C-corp, you will be seen as a sole proprietorship in the eyes of the IRS. This is considered a disregarded entity. What this means is that you are not considered an employee of the LLC and all the profits just pass onto your personal tax return at the end of the year. This can cause trouble around tax time if you do not budget for it!
If you decide not to elect as an S-corp or C-corp, you will pay yourself as an “owner’s draw” or “distribution.” This process is simple. All you do is either write yourself a check, withdraw money from the bank, or transfer money over to another account. Make sure you document this distribution in your books for tax time. That is it!
Be careful about your taxes though. When you make a draw, it is not taxed until you report it. Therefore, if you are making owner’s draws frequently, you will have a large tax bill at the end of the year. This is why it is important to talk to your CPA about setting up a quarterly tax payment, so you do not get into trouble at the end of the year.
If you decide to file as an S-corp on the other hand, you will have to write yourself a legitimate paycheck. You will be considered a W-2 employee of the LLC. This means that every time you pay yourself, taxes will be taken out just like with a normal job. This is where you can be creative.
The IRS states that your salary should be reasonable and the average for your profession. Well, nurse practitioner salaries vary widely throughout the country. Therefore, it is hard to determine what is “reasonable.” I would pay myself $50 an hour. That is average in some parts of the country.
So, if you work 10 hours a week on your side practice, you will pay yourself $500 a week in salary. Well, what happens to the rest of the practices profit? It is distributed to you. Distributions are passed onto your federal income tax, but they are not subject to employment taxes (Social Security and Medicare). The amount taxed based off the distribution is to confusing to discuss in this article, so that is something you would need to discuss with your CPA. In general, you usually will save a lot of money on taxes utilizing an S-corp and distributing the profits after you have paid yourself a salary. After you pay yourself through a reasonable salary and distributed profits, you might want to keep some retained earnings in the bank to cover expenses for the next year. Unfortunately, that amount will be taxed as your personal income in an S-corp. That is one downside of this business structure.
If you decide to file as a C-corp, you will pay yourself as an employee and through dividend payments. Dividend payments aren’t subject to payroll taxes, but they are subject to income taxes. The main issue with a C-corp though, is that the businesses profit is taxed before its distributed to its owners. Therefore, it is a “double” taxed entity. The main benefit of a C-corp is that retained profits are only taxed at the flat 20% corporate tax rate, therefore you can keep money in the company at a lower tax rate than your higher income tax rate. You should avoid a C-corp unless you end up creating a massive enterprise and want the superior asset protections they offer. If you are operating small nurse practitioner ran side practices, you do not need to form a C-corp, don’t confuse yourself with this entity. Stick to an LLC or an LLC with an S-corp election. Paying yourself through these structures is easy and straight to the point.
Remember, that owner’s draws through a basic LLC that is treated as a sole proprietorship are subject to federal income tax and employment taxes (Social Security and Medicare). Distributions paid to you after your reasonable salary through an S-corp are subject to federal income tax but not employment taxes (Social Security and Medicare). That saves you a large sum of money a year, like 15% in taxes… Not to mention all the other tax perks owning a business provides. This is why I recommend utilizing the S-corp structure. That is what each of my operating LLCs are (men’s health clinic, medical cannabis, telemedicine practice). These generate significant revenue. My rental properties, on the other hand, are just titled under a basic LLC treated as a sole proprietorship as these do not generate that much income but are wealth building assets instead.
As always, consult with your CPA, legal professional or adviser before implementing any advice provided.