What does it really mean?  And why you should care!

If you’re in business, you’ve probably noticed the term “Reasonable Compensation” has been in tax news more than ever in recent months.  It’s not a new term, but it is receiving new attention by the IRS.

Who should care?

Anyone associated with a Subchapter S Corporation.  You might call yourself an owner or a shareholder or even a partner.   (I’m going to use ‘owner’ because it is short.)

Why?

Part II:  Why Michael Gerber deserves to have a statue on Main Street

After insulting the backbone of America by saying there is no such thing as a “born businessman,” Michael Gerber concedes that it is nonetheless possible to be a successful businessman.  It is his observation that a successful businessman is one who employs systems to get the work of his business accomplished, and much of the actual content of the E-Myth books is actually demonstrating this point.  Indeed, Mr. Gerber’s consulting business essentially entails helping folks develop their own systems.  While it is a shame that he had to take a nasty swing at entrepreneurs in general in order to get our attention, his focus on systems has been good for pretty much everyone.

Part I:  Why the book made me mad

A friend recommended I read Michael Gerber’s The E-Myth, and so I did.  The book has received great press over the years, in a sort of wow-I-never-thought-of-it-that-way bewilderment of praise.  While it cannot be denied Gerber put voice to a little-observed phenomenon, I believe the way he did it did a disservice to entrepreneurs, and people in general.

Essentially, Gerber’s E-thesis is, like leprechauns and the tooth fairy, there’s no such thing as a natural-born entrepreneur.  What he calls an ‘entrepreneur’ is really just an ordinary — albeit technically proficient — person who suddenly realizes he doesn’t like his boss and/or could do things better than his boss.  In that fit of pique, the ordinary person quits his job, sets up his own shop, and proceeds to fail.  Why does he fail?  Because despite being technically proficient, he doesn’t know how to run a business!

Why do services cost so much?

Did you hear the one about the heating contractor/washer repairman/lawn mower guy?  The homeowners, at wit’s end, finally call for help to get the system back in action.  The contractor shows up, listens to the tale of woe, inspects the equipment, considers the noises being made, then takes out a hammer, and whack! hits the equipment soundly in a particular place.  The system immediately comes back online, no weird noises, no vibrations.  The homeowners express amazement and gratitude.  The contractor presents an invoice.  The homeowners gasp.  “But you’ve only been here 5 minutes!” they cry.  “All you did was hit it with a hammer!  We could have done that ourselves!”  “Yes,” replies the contractor, “but I know where to aim.”

Experience.  A large part of why a service costs so much is the sum total of the experience of the service provider. 

It’s better to give than to receive.
– My mother (and possibly yours), transliterating Acts 20:35

Charity is people with more than they need, giving that ‘more’ to other people who don’t have enough.  Charity is recognizing that no matter how high you push the thermostat, you aren’t going to get more comfortable; no matter what you pay for your steak, the plate will be clean in 20 minutes; no matter how much gas your vehicle guzzles, the tank will soon be empty, and furthermore, recognizing there are plenty of other people with no heat, no food, and no way to get around – and then giving of your own time and/or money to do something about it.

Charity is sharing.

When start-up expenses don’t count

You know the perfect new business. It’s right up your alley. You spend nearly a thousand dollars on a fancy lawyer who registers your name, gets you a federal ID, and establishes you in Delaware (for tax purposes, of course!) as well as your home state. You even spring for a p.o. box and slick business cards. Maybe even buy a slim new top-of-the-line laptop.

But then life gets in the way. You meant to run ads. You wanted to hire a salesman. You were going to order inventory. Heck, you were going to make Real Money so you could quit the day job. But after three or four years…nothing.

Consider this. Let’s say I dig a foundation intending to build a house, but I never do anything beyond arranging for the delivery of several dozen pallets of block. Or I buy a dress pattern and cloth intending to make a dress, but after I lay it out on the table, I never even cut the cloth. Or I take books out of the library but don’t open them. Or I register for classes but never show up.

How to head off under-withholding penalties

Let’s say you run a business, and take a small salary.  And let’s say you had a great year!  If your business is an LLC or S Corp, or even a sole proprietorship, that great year is going to find its way to your personal 1040, and you’re going to have to pay tax on it.

But you’re already contributing with withholding from your small salary, right?  Isn’t that good enough?  Well, if it’s been enough in prior years, and this year is especially good, then probably not.  And not only will you owe income tax and self-employment tax, but you may be subject to underpayment penalties.

The IRS (and the State of New Jersey, as well as most other taxing jurisdictions) expects you to contribute “ratably” throughout the year, just like a W2 employee.  It goes like this:  a W2 worker has taxes withheld every time he or she gets paid.    If the paycheck is large, the government gets more.  If the paycheck is tiny, the government gets less.  But either way, the government gets its cut way before April 15.  And they want this from the self-employed community, too.

Are you ready?

Haunted Hayrides.  Reruns of creepy classics.  Grocery store clerks dressed up as Frankenstein.  It must be the scariest time of the year, right?

No.  The scariest time of the year, for way too many people, is tax season.  This is because way too many people fail to plan for the inevitable.  That’s right:  you’re going to pay taxes whether you like it or not, so why not take control of the situation?  Find out in advance what it’s going to look like.  See if there’s anything you can do, now, to ameliorate the situation.