Despite the majority of businesses being started by someone wanting to make money, many of those business owners don’t actually know the best way to pay themselves.
From fixed salary to owner’s draw, or a combination of them both, how you pay yourself as a business owner depends entirely on the way in which your company is structured, your tax strategy, and plans for growth. Make the wrong choice, however, and you could find yourself under intense IRS scrutiny, or paying out more than you needed to in taxes.
Whether your entity type is S Corp, LLC or sole proprietor, how you pay yourself as the owner of a business varies, and your options range from owner’s draw or salary, and dividends. Sitting down with an expert in accounting in Coral Gables, is the best way to understand the implications of each option from a tax and compliance perspective. But in the meantime, a basic understanding of how you can pay yourself, can be helpful. Let’s look at the options:
Salary or Draw?
Business owners can choose to pay themselves through dividends, or a combination of draws (taking profits) and salary (W-2 wages).
Salary: tax withheld and predictable, this is necessary for S Corps that perform services.
Draw: only taxed when withdrawn and flexible, LLCs and sole proprietors commonly use this method.
Dividends: double taxation is possible with this option commonly used by C Corps.
Paying yourself in an LLC
Owners of LLCs can pay themselves through draws, or if opting for S Corps status, by way of salary and distributions.
Single-member LLC: use of schedule C to report owner’s draw
Multi-member LLC: use of K-1 to report distributions taken by members
LLC taxed as S Corp: a ‘reasonable’ salary must be taken along with optional profit distributions
Sole proprietor payments
Owner’s draws are taken by sole proprietors instead of salaries:
- profits pass through to personal tax return
- self-employment tax is applicable
- no requirement for a W-2
Payments to S Corp and C Corp
A business that has been structured as a corporation pays its owner either as an employee with a salary, or a shareholder with dividends.
S Corp: if actively working, a ‘reasonable’ salary must be taken and profits beyond salary that aren’t subject to payroll tax, may be distributed.
C Corp: normal taxes apply to salary, but dividends face double taxation at both corporate and personal level.
Considerations state-by-state
Each state may have different compliance and threshold rules for business owners paying themselves, below are some examples:
New York: based on their income bracket, LLCs pay annual filing fees
California: ‘reasonable compensation’ rules must be met by owners of S Corps
Florida: for S Corps, unemployment insurance applies, but there is no state income tax
Texas: franchise tax applies, but state income tax doesn’t
A step-by-step guide to paying yourself as a business owner
The best way to ensure that you’re paying yourself correctly, is to work with professional bookkeeping in Coral Gables, who will help you gather the necessary documents and liaise with a small business tax expert where necessary.
Below are the steps needed to pay yourself properly:
- select an entity structure with guidance from a tax expert
- open a business bank account (and keep your personal money out of it!)
- use payroll software if salary payments are required, or work with an accountant who already uses payroll software
- make sure that all owners draws or distributions are well documented
- file quarterly estimated taxes
Although it may seem simple: set up a business, start making money, get paid, it’s important to recognise the tax implications of how you pay yourself. More than just the money, paying yourself involves taxes, compliance and strategies for growth.