How to Differentiate Personal and Company Taxes as a Business Owner

In the latest edition of Markup and Profit, a business owner asks Michael Stone how to correctly differentiate taxes between the company and owner.

"Do we consider taxes on the owner's salary in our calculations for overhead, or our own self-employment taxes (we both do on the job work and figure in an hourly wage, though we do not withhold payroll taxes for ourselves or classify ourselves as employees...), or do we not really worry about this since this is actually paid at the personal level? "

Here is what Michael Stone has to say.

Draw a line between your business finances and your personal finances. The business pays its taxes. You pay your personal taxes from your salary. Your salary is included in your overhead as a pre-tax amount.

Let's say you need $80,000 per year to pay your personal bills and set aside funds for savings and giving. Current tax brackets would put you in the 25 percent tax bracket (married filing jointly). Find the reciprocal by subtracting your tax bracket from 1; in this case, your reciprocal is .75. Divide $80,000 by .75, and you'll get $106,667. Include $106,667 in your overhead expenses when you calculate your markup. With a salary of $106,667, you can pay 25 percent in taxes and still have $80,000 to live on.

At the other end of the spectrum, if your business is able to make a profit on top of your eight percent salary (as you should if you're pricing your jobs right), the profit your business makes will probably, depending on your legal structure, be considered personal taxable income, even if you choose to keep the profit in the business. If that's what your business is facing, be grateful and start setting aside funds.