Business people are often misled by their investments in their own companies. How much to invest in the company and how much to pay to themselves? These are constant questions of operating a business.

Business people who borrow money from their companies frequently face an I.R.S. challenge. To win the case they need to have a signed note with a repayment schedule and a stated interest rate. Otherwise, the tax people are likely to view the loan as a dividend, taxable to both the business and the owner. There are more and more cases where the I.R.S. has accused business owners of family-owned S corporations of underpaying themselves.  

So, how much to pay and how much is right? The amount depended on the business and on its industry. One of the creative things business people do to keep themselves from running afoul of the I.R.S. is to keep careful minutes of board meetings and record any bonuses paid, making clear that they are performance related, not paid because the owner wanted a new car or luxurious dwelling.

Another is to insure that compensation is based on service rendered, not on the percentage of stock held. The I.R.S. is likely to view payment for stock holdings as a dividend. The last one can’t be deducted as a business expense, but compensation can be, however. The third one is to convert to an S corporation, the entity which allows earnings flow through to the owners, rather than being retained at the corporate level. This type of corporation is not always preferable, because of the various restrictions on S corporations, where only one class of stock and the corporation is must have 35 or fewer shareholders, all United States residents.

In case you go on a regular C corporation, compensation should always reflect performance, not a current performance, however. Although it’s very easy for business people to identify themselves with the company and to feel the ownership, legally the company is a separate entity, and the legal standard of financial operations including owners’ compensation packages is reasonableness. 

“Home based business”. These magic words make business people search on the Internet for new business ideas. True enough, nobody likes to commute every day and to work in the office. What business people need to know about home based business is all about online business, technology changes and if they are doing any business offline how to bring it online. The video I posted today is a brief introduction to the project.

It should be noted if online business is your passion and it generates even some income, IRS will treat you as a regular business. In other words, you still need to pay taxes. 

However, according to “Silicon Molds Blog” there are several tax advantages of doing business online. Personal expenses, such as the use of your car, home or computer may become partially deductible, retirement savings plans can shelter part of your eBay income from taxes, and you may be able to hire your family to help shift income to members in a lower tax bracket. So even if you only earn a little money online, not only are you required to report your earnings, it may even help you reduce your income taxes by taking advantage of tax opportunities available only to small business owners.

Generally, any income you receive from all sources is subject to U.S. income tax unless it is specifically exempt by law (hint: online profits are not exempt by law). That means that a lot of activities that you might not think of as taxable, such as garage sale income, gambling winnings, and online businesses are taxable.

In a nutshell, an approach to the online vs. offline businesses should be comprehensive and tax issues need to be considered very well. Enjoy your weekend!