Taxes and Profits and Shares, Oh My!

My corporate tax return is amazingly complex for such a small, simple business. I’m not even sure about the size of Kraken’s profit. “Ordinary business income” was $7,018. “Income reconciliation” from Schedule K came out to $5,999 – pretty close to my $5,900 estimate. One of those two numbers is my personal taxable obligation. The number on my state return is midway between those two values.

I spent a lot of time on taxes this week. I e-filed federal and state returns for my mother-in-law, pored over the Kraken returns, and paid my annual $456 excise and $109 registration to the state. Then I did my part of compiling our personal return. Now it washes up on Anne’s desk, where it will molder until April. She gets a one-week grace period before I start nagging.

Although I didn’t take out the whole profit upon which I’m taxed, I technically made $17,888 last year if you use the higher K-1 figure or $16,869 using the lower one. Either way, Kraken’s profit was almost half of my income. Is that excessive?

Like taxes, it’s complicated. K-1 income is immune to Social Security and Medicare taxes, but I leave roughly 25% of it in the company (retained earnings) to fund growth. I can’t take out my share until December sales define the number; that’s when I get my best paychecks and need the bonus bucks least. It’s tempting to funnel most of that “extra” $7,000 (or is it $6,000?) into payroll, where I’d lose more to taxes but get to collect it throughout the year and make my W-2 income a little less embarrassing. But as the bankers say, past performance is no guarantee of future results. I underspent on technology and site improvements last year. Spending the budgeted amounts this year will reduce the bottom line. It’s tempting to skimp on these investments to keep the profit up and the shareholders happy. But you have to spend money to make money; if I do it right, it will pay off in increased sales and bigger profits.

Besides those quantifiable considerations, any number of other things can threaten Kraken’s profit and reduce my own annual income.

Take, for example, the postage hike dilemma. I wrote about the fine art of shipping a couple of years ago. Postage fees and outlays comprise about 15% of my cash flow; I need to get them right. Years of experience have brought most products’ shipping fees and costs into line (with a very slight bias in my favor) despite such complications as flat-rate boxes, dimensional pricing, residential delivery surcharges, and more.

In January the USPS raised rates on Priority Mail and Express Mail; First Class and Parcel Post rates stayed the same. Customers usually choose the least-expensive Parcel Post option, and I've always upgraded those orders to either UPS Ground or Priority Mail. The upgraded price is still at or below my actual cost, the customer gets better service than they paid for, and everybody’s happy.

Or was until now. Priority Mail rates went up and Parcel Post did not. That means that my shipping costs rose while the fees I collect – which come from rate table lookups -- didn’t. The advent of zoned pricing sometimes makes West Coast upgrades a losing proposition. Shrinking the small spread between fees collected and costs paid out is harming my bottom line.

To rectify that, I could:

1. Raise my handling fee. But that penalizes my First Class, UPS, and east coast customers.
2. Increase product weights. But that punishes my most desirable customers – those who buy multiple products at once.
3. Eliminate Parcel Post. But taking away the lowest-priced option would make my shipping charges visibly higher and harm a competitive advantage.
4. Leave everything unchanged and accept the smaller spread. But that makes it more difficult to reach my sales plan (which I calculate based on net sales after shipping costs) and ultimately comes out of my pocket.
5. Actually ship via Parcel Post more often. But shipments that now take 2-3 days would take 7-10 days. Customers won’t like that.

For now, I’m watching number 4 nervously. If the higher Priority Mail costs ding my net sales too badly, I’m going to have to adopt either number 3 or number 5.