It is a common question among most business owners: how can you pay yourself when you are also the business owner? It is like you are the employer and the employee at the same time. However, it completely depends on the entity structure within your business. You should understand how you are operating your business, and based on that role, you can set a salary for yourself. There are various aspects to consider, as this approach requires ethical values and also considering the complete structure of the business entity.
Do you operate as an S corporation, C corporation, LLC, partnership, proprietorship, or something else? Based on that, you can pay yourself in various ways, including payroll, guaranteed payments, dividends, or owner draws. It is highly important to understand the rules that allow you to stay compliant and choose the right compensation strategy, which also helps you avoid tax surprises. Let’s take a better look at each structure.
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Sole Proprietorships
In the case of Sole Proprietorships, the business owners are not considered employees, and therefore, there is no fixed salary of compensation for the owner. Instead of wages, they get paid by “owner draws,” which basically means they can draw money from a share of their company profits. It is a simple method where they write a check to themselves or transfer funds, which allows adding the profits from the professional account to personal accounts. This is not a paycheck, and therefore no self-employment tax is paid in this case.
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General Partnerships
A partnership is a multi-owner pass-through structure where all profits and losses run through multiple owners. Since the partners are not considered employees of the company, they do not receive any wages or salaries. They can either get paid through owner draws, guaranteed payments, or both in some cases. Business income is reported on the 1065 partnership tax return, and Schedule K-1 forms are issued for each partner to share their profit, loss, and tax obligation. The annual individual tax returns for each partner are estimated in every quarter.
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Limited Liability Companies (LLCs)
LLC owners cannot be considered employees either. They cannot receive compensation from salaries and wages either. For tax purposes, an LLC is considered a partnership or sole proprietorship by default. The option of how members will get paid depends on how many members are in the LLC. The payment varies based on whether it is a single-member LLC or a multi-member LLC.
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S-Corporation
The LLC structure has some flexibility when it comes to payments. When an LLC meets the IRS qualification criteria, it can be considered an S Corporation. However, in this case, the company must put the shareholders on the business payroll through a reasonable wage or salary.
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C-Corporation
An incorporated for-profit entity can be considered a C Corporation, which comes with separate tax structures from the owners. Shareholders who perform work should be on the company’s payroll and receive salaries. The corporation must withhold FICA tax and Income tax from salaries or wages. They must file a corporate tax return and pay corporate income tax to stay compliant.
Dealing with the financial structures, keeping tax returns right, and paying yourself rightfully requires professional help. So, if you are trying to pay yourself, you must pay a legal adviser to develop a strategic approach so that you can pay yourself as an owner.
