“Knowing how to pay yourself can feel like one of those ‘Shouldn’t I know how to do this if I am running a business?’ kind of questions, but in reality, it’s a question that many farmers and ranchers have. And they don’t have a clear answer to,” said Eva Moss.
Moss is the education program director at Farm Commons. Moss and her colleagues discussed strategies for paying yourself as a farmer in one of Farm Commons’s recent podcasts. Each podcast explores real legal issues faced on farms every day, providing knowledge and tangible solutions to help grow thriving agricultural businesses.
One way a business owner can get paid is the owner’s draw – a business owner taking funds out of the business for personal use. Examples include withdrawing money from the business checking account at an ATM, using the business credit card for personal items or writing oneself a check.
“It’s a really flexible mechanism for paying oneself,” said Rachel Armstrong, executive director at Farm Commons. “The business owner takes out the funds when they feel they need it.”
Business owners can pay themselves at regularly scheduled intervals, or the compensation can fluctuate depending on the business’s performance.
If the business is a sole proprietorship, a partnership or an LLC (operating as a sole proprietorship or partnership), the IRS only permits the owner’s draw. With an owner’s draw, all payroll taxes are paid by the owner either at intervals or at the end of the year. The draw itself is a non-tax-deductible expense.
When business owners take a draw, they must be aware that in accounting terms they are reducing the equity of the business. These monies could also be used to pay bills or to reinvest in the business. In deciding how much to pay themselves, owners must make sure they remain capitalized – having enough funds to meet their financial obligations.
In deciding how to pay oneself with an owner’s draw, Armstrong said, “Every business is different and the best answer is to use a cash flow budget to help chart some accurate expectations for when money is going to be available to you personally in the natural course of your business.”
Another way business owners can pay themselves is via salary. Only certain business structures allow for business owners to pay themselves this way – for example, S corporations and LLCs, if they elect to be taxed as a corporation.
With a salary, the business owner becomes an employee of the business, and the business pays its share of payroll taxes. Wages paid are a deductible business expense.
In some circumstances, it may be advantageous for taxation purposes for a business to change its business structure. “The bottom line is if a person wants to optimize their tax outcome, they’ve got to get into the details, and that usually requires working with a professional,” Armstrong said.
While it might take an accounting expert to take on the specifics of taxation, farms should strive to take on the communication portion of how and when people get paid. This is especially important if the farm is a partnership. It doesn’t have to be complicated.
Moss cited an example where farm owners decided to structure their owners’ draws using time sheets. The owners punched in and out with a time clock, and they were entitled to an owner’s draw based on the amount of time they worked in a given period.
According to Moss, ideally these decisions should be memorialized in writing in governance documents. “If you’re a partnership, you write that into your partnership agreement. If you’re an LLC, write that into your operating agreement. Corporation, you’ve got your bylaws,” Moss said.
Moss suggested taking these four questions into consideration before setting up a written agreement: What are the most important factors to use for compensating ourselves? How often do we need to get paid? How do we adjust our compensation if the business is struggling? And how do we adjust our compensation if the business is doing well?
by Sonja Heyck-Merlin