Paying yourself as a business owner is not just about the money—it’s also about your mental health and ability to keep going. Successful business ownership is as much about your ability to thrive financially and provide for yourself as it is about future business profits and growth. So how do you legally pay yourself as a business owner? Well, it depends on the type of business you own. Whether you are a sole proprietorship, a partnership, or a corporation, it’s essential that you reward yourself monetarily for the hard work and effort you are putting into your growing business. Below, we’ll explain how to choose the best method for paying yourself as a business owner in a way that makes sense financially and practically for your specific situation. In the process, you can learn how to pay yourself with an owner’s draw or paycheck, how each method is taxed, and when to change your business entity status.
Owner’s Draw vs. Salary
Pros and Cons of Owner’s Draw
This method is the best for limited liability companies (LLCs), partnerships, and sole proprietorships.
Pros and Cons of Salary
Also called “salary at a glance,” this method is the best for S corporations, C corporations, and nonprofit organizations.
How To Pay Yourself From an LLC, Partnership, or Sole Proprietorship
If you are a sole proprietor or in a partnership, you must pay yourself or your partner as employees. For an LLC, the process is similar. The only significant difference is the legal separation between the LLC members and the business itself. Perhaps the best way to pay yourself for these three business structures is through the owner’s draw, distributing funds as needed throughout the year as your business grows. Here’s how to pay yourself from an LLC, partnership, or sole proprietorship:
How To Pay Yourself From an S Corp or C Corp
If you operate an S corporation or C corporation, there are three different processes for paying yourself as an owner. You can take home your pay through a salary, distributions, or a combination of both. The IRS has a set of rules that determine how much you can pay yourself as a business owner. These rules differ for S and C corps.
S Corporation
An S corp is a type of corporation taxed as a partnership. The business’s income is passed to its shareholders as dividends. Those in an S corp are responsible for paying individual income taxes on it. S corps do not have to pay taxes on profits, but its shareholders must pay taxes on their dividends. Since S corps are structured as corporations (with shareholders), there is no owner’s draw, only shareholder distributions. If you need consistent paychecks, you must take a salary as a W-2 employee. Small businesses often use the S corp structure because it allows them to avoid double taxation. S corporations are only taxed once at the individual level when dividends are distributed to owners or shareholders. However, there are some limitations set by the IRS. If you want to take more than a reasonable salary, you must convert your S corp to a C corp or LLC.
C Corporation
A C corp is different from all the other types mentioned in that double taxation applies, wherein it pays taxes on its profits and the owner pays taxes on any dividends they receive. C corps are taxed at a higher rate than individuals but have more benefits.
C corporations are taxed at the corporate level and then at the individual level when they distribute dividends to shareholders. A C corp can deduct business expenses from its taxable income, which lowers its overall tax amount.The IRS has no say in your salary, and it cannot deduct anything from your earnings if it exceeds the minimum wage.
The Bottom Line
Every business owner needs funds for personal expenses and living costs. Different methods are used to pay yourself depending on the type of business you own. First, determine the type of entity your business is and how you want your business to be treated for tax purposes. Calculate how much money your business can afford to pay out in salaries, owner’s draws, dividends, or distributions each year and how much you need for your personal expenses.Finding the difference between those two amounts is essential before deciding how much money should be paid out from the business’s profits. When in doubt, refer to the IRS website for specific lists of frequently asked questions on each type of business entity and payment structure. You will need to file articles of incorporation with the state in which you are incorporating your nonprofit. You should also apply for tax-exempt status with the IRS and Franchise Tax Board, which can take up to six months or more before approval is granted. Once that is done, similar to an S or C corp, you can pay your officers or shareholders dividends from net profits.
title: “How To Pay Yourself As A Business Owner” ShowToc: true date: “2023-01-28” author: “William Briggs”
How Business Owners Pay Themselves
This schedule shows how different types of business owners get paid and how that pay is shown on their tax returns.
Your business type, The stage of business you are in now, andHow much you need for personal expenses.
The difference between a draw and a distribution is significant for tax reporting purposes.
A sole proprietor or single-member LLC owner can draw money out of the business; this is called a draw. It is an accounting transaction, and it doesn’t show up on the owner’s tax return. A partner’s distribution or distributive share, on the other hand, must be recorded (using Schedule K-1, as noted above) and it shows up on the owner’s tax return. In the same way as a partner, a member of a multiple-owner LLC and an S corporation shareholder take a distributive share, with the amount recorded on Schedule K-1.
Sole Proprietors Take a Draw
If you are a sole proprietor you are not an employee and you don’t take a salary in the form of a regular paycheck. No FICA taxes (Social Security/Medicare) are deducted and no federal or state income tax is withheld. A sole proprietor gets “paid” by drawing money from the business. Amounts taken out of a business by a sole proprietor may be called a draw because these amounts draw down your capital (ownership) account. Read more about how the owner’s draw works.
Partners Take Distributions From Profits
A partner in a partnership also does not get paid a salary. They take distributions from partnership profits and are taxed based on their share of those profits on their partnership income tax return. How profits are distributed in a partnership or LLC depends on the language of the partnership agreement or LLC operating agreement.
LLC Owners Take a Draw or Distribution
Owners of limited liability companies (LLCs) (called “members”) are not considered employees and do not take a salary as an employee. Single-member LLC owners are considered to be sole proprietors for tax purposes, so they take a draw like a sole proprietor. Multiple-member LLC members are considered to be like partners in a partnership, so they take a distribution.
Corporate Shareholders Receive Dividends
An owner of a corporation or s corporation is a shareholder, and as a shareholder, he or she takes dividends when the corporation’s board decides to pay them. But many growing companies don’t give dividends but put the profits of the corporation back into growth.
S Corporation Owners Who Work in the Business Get a Salary
Corporation and S corporate officers who are involved in the day-to-day running of a business are considered employees and they must take a salary and employment taxes must be paid on that salary. In addition, S corporation shareholders may take additional distributions of profit from the business. Some S corporations try to pay minimal amounts to corporate officers to avoid employment taxes, but the IRS says corporate officers must be paid a reasonable amount. The IRS has established guidelines for determining a reasonable salary, based on experience, duties and responsibilities, time spent, comparable amounts paid to others doing similar work, and other factors.
How Much to Take From Your Business
Business owners who take a draw or distribution of profits can take any amount they want from their business. Of course, you shouldn’t take money that will be needed to pay employees, pay off business loans, or pay other bills of the business. The National Federal of Independent Business says: Later in your business life, you may be able to take money from your business on a more regular basis, based on your personal financial situation.
How Self-Employment Taxes Work for Business Owners
Self-employment tax is Social Security and Medicare tax for business owners. The amount of self-employment tax you must pay is based on the profits of your business; if the business does not make a profit in any one year, no self-employment tax is due. These amounts are not withheld from any payments to business owners. Of course, these taxes are still due and payable at tax time. Sole proprietors, partners, and LLC members must pay self-employment tax when they complete their personal tax returns for the year. (S corporation owners are not considered self-employed.) The self-employment tax is calculated and added to the income tax due; self-employment taxes are paid to the IRS along with federal income taxes.
