As a business owner, one of the most common financial questions you’ll face is how to properly pay yourself. The method you use depends on your business structure, and getting it right is essential for tax compliance and financial efficiency. Here’s a breakdown of how different business entities handle owner compensation.

Sole Proprietors and Single-Member LLCs

If you operate as a sole proprietor or a single-member LLC, your business income is considered personal income, and you cannot be on payroll as an employee. Instead, you compensate yourself through owner’s draws, which means transferring funds from the business to your personal account as needed.

• You report net earnings on Schedule C of your personal tax return.

• Your income is subject to self-employment taxes (15.3%), which cover Social Security and Medicare.

• Since there’s no formal payroll, you don’t have to withhold taxes on your draws, but you should make quarterly estimated tax payments to avoid penalties.

Partnerships and Multi-Member LLCs

Partners in a partnership or members of a multi-member LLC cannot be employees and therefore do not receive W-2 wages. Instead, compensation is structured in two ways:

• Guaranteed payments: These are fixed payments made to partners for their services, similar to a salary. They are taxed as income and are subject to self-employment taxes.

• Profit distributions: Partners receive a share of the business profits based on the partnership agreement. These are also subject to self-employment taxes unless the partner is a passive limited partner.

Cash withdrawals are made through partner draws or profit distributions, but it’s crucial to plan accordingly for tax liabilities.

S Corporations (S Corps)

An S corporation allows business owners to be employees and receive a salary, but there are specific rules to follow:

• You must pay yourself a reasonable salary as an employee via W-2 wages. The IRS requires this to prevent underpayment of payroll taxes.

• Your salary is subject to FICA taxes (15.3%), which are split between you and the corporation.

• Any additional profits after payroll expenses can be distributed as dividends, which are not subject to self-employment taxes, offering potential tax savings.

• Payroll taxes must be withheld from your W-2 wages, and you must file quarterly payroll tax reports.

C Corporations (C Corps)

A C corporation is a separate legal entity, meaning the corporation itself pays taxes at a flat 21% corporate tax rate. Business owners can be compensated in two primary ways:

• W-2 wages: Paid as an employee, subject to payroll taxes.

• Dividends: Distributions from profits, which are taxed twice—once at the corporate level and again at the personal level when received.

To minimize double taxation, many C corp owners choose to take a reasonable salary and distribute profits strategically.

Key Takeaways and Best Practices

Regardless of your business structure, it’s important to:

• Keep clear financial records separating business and personal expenses.

• Ensure compliance with IRS rules, especially for S Corp reasonable compensation and C Corp tax planning.

• Set aside funds for estimated taxes if you’re not on payroll.

• Work with a tax professional to determine the best compensation strategy for your business and tax situation.

Paying yourself correctly is vital for maintaining financial stability and staying compliant with tax regulations. If you’re unsure about the best approach for your business, let’s talk! We can review your structure, evaluate tax-saving opportunities, and ensure you're maximizing your financial benefits.