July 2021

Paying Yourself as a Business Owner

Small startup business owner concept. two successful young baristas women standing in bar counter in cafe. happy coffeehouse waitresses in aprons smiling confidently to camera in coffee shop.

Owning a business is challenging and hard work, so you’ll want to compensate yourself appropriately. How you do that depends on the structure of your business.


SOLE PROPRIETORS (SOLE PROP)
As self-employed taxpayers, sole props aren't employees and aren't paid a salary. Therefore, when sole props need to take money from the business to pay themselves, they take draws.


Draws aren't taxed when they are taken. Instead, because a sole prop is a pass-through entity, all of the business's income is taxed on the owner's tax return using Schedule C. And self-employment tatx will be calculated on Schedule SE.


PARTNERSHIPS
Like sole-props, partners in a partnership aren't employees. Profits from the business are distributed per the partnership agreement. These are called distributions or guaranteed payments.


Partnerships are another type of pass-through entity. Partners receive a Schedule K-1 that reports their share of the partnership's income. And partners pay income and self-employment tax on their individual tax returns similarly to sole props.


LIMITED LIABILITY COMPANIES (LLC)
If an LLC has only one owner, called a member, it's treated the same as a sole prop for tax purposes. If there are two or more members, it's treated as a partnership for tax purposes by default. Regardless of the number of members, any LLC can elect to be taxed as an S-corporation by filing Form 8832.


S-CORPORATIONS
As an S-corp owner, you are also an employee and will need to be paid a reasonable salary. What's considered reasonable depends on many factors including your industry, responsibilities and experience. This means the owner and the S-corp must submit payroll taxes. The owner reports these W-2 wages on their tax return, and the remaining business profit flows through to the owner's tax return via a Schedule K-1. However, since the IRS doesn't consider the owner of an S-corp to be self-employed, these earnings aren't subject to self-employment tax.


STATE TAXES
State income taxes vary so consult with your tax professional about how your company's profits will be taxed locally.


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