taxes, payment, contractorsSo, three people did a web application together for a client, each as an individual contractor. We are not in an LLC together, nor did we interact at any point with this client as an LLC - always as contractors. Total payment for the project was 10k. We agree before the project to split the profits equally (each getting a third of the profits).
My thought was to have our client write 3 separate checks for $3333, giving each of us our cut. That seemed the easiest and most straight-forward.
But, one partner doesn’t want that. He had the client write a check to him directly for the complete $10,000. He wants to give me $2500, another guy $2500, and but keep $5000 in his account; out of the $5000, he will pay himself $2500, but keep the rest in there to help pay for taxes (so $2500 for him, $2500 for taxes). Specially, he is worried that he will be taxed more than us because he was paid 10K, instead of $3333. He also said he had the client cut him 1 check for 10k instead of 3 checks for $3333 because it was easier for their accountant.
He says that once he pays himself $2500, and pays any extra taxes due to the fact he was paid 10k vs our $3333, he will take whatever is left and split that with us come April.
We still have to pay taxes on our $2500 and any money “left over” from the $2500 he put aside that might come in April.
This seemed really confusing to me. I said to him the best way is to just split the money $3333 each and we pay our own taxes. Plus we all get our money now and me and the other guy don’t need to be taxed twice.
Am I missing something though? He is always saying how he is talking to his accountant about this. Is there any angle I’m missing? Can he save us more money his way or is a $3333 equal split just better?
No idea where you live, and the information would be necessary to give a better answer, but FWIW where I currently live your partner wouldn’t have withheld enough.
It seems you guys haven’t incorporated a business. So you’re technically correct in this particular case that you’d have been better off with three separate checks.
As things stand, he’ll likely be on the hook for the initial $10k of income on his end, plus whatever taxes and social benefit-related contributions he needs to pay on what he paid you. Your sentiment is correct that the revenue he paid you could end up getting taxed twice.
By contrast, a corporation would have been taxed on the final profit instead, and you could have brought the latter to zero. (Or you could have paid the corporate tax on part or all of the initial income and distributed the balance as dividends, if that makes sense where you live.)
That being said, many countries have some kind of status whereby you’re operating as a de facto (unlimited liability) business or something to that effect, so there might be hope to avoid the worst case scenario with the help of your accountant.
File this under lessons learned, and incorporate a business if you plan to work together again.
The general rule of thumb that served me well when starting out was to save half of what I made as a contractor. This will cover any taxes at the end of the year and if you saved too much it is a nice bonus at tax time. Once you have a company set up and you are writing off expenses you will get a feel for how much you need to save out.
Based on the above rule of thumb he will pay $2500 in taxes and pocket $2500. You will pay $1250 in taxes and pocket $1250 as will your other partner. On the surface It looks like he will be pocketing an extra $1250.00. If you would have all taken an equal 1/3 each of you would have $1666.50 after taking half out for taxes.
All content is licensed under CC BY-SA 3.0.