As a successful business owner, determining the most effective way to pay yourself involves navigating a maze of tax rules and entity structures. Whether you’re optimizing for tax benefits or planning for future growth, how you compensate yourself can impact both your personal finances and business sustainability.
Entity-Specific Compensation Strategies
- Sole Proprietors and Single-Member LLCs: For sole proprietors and single-member LLCs not taxed as corporations, compensation is straightforward. You cannot be on payroll, nor do you receive a W-2. Instead, you take an owner’s draw—withdraw money from your business earnings as needed. These draws are not subject to payroll taxes; however, your net business income will be subject to self-employment taxes, which you report on Schedule C of your personal tax return.
- Partnerships and Multi-Member LLCs: In a partnership or a multi-member LLC taxed as a partnership, partners are not employees and should not receive a salary. Instead, you may receive guaranteed payments for services or a share of the profits, both subject to self-employment taxes. Ensure these payments align with your partnership agreement, and avoid treating these draws as W-2 salary to prevent tax issues.
- S Corporations: S corporation shareholders often benefit from a unique tax-saving strategy. Pay yourself a reasonable salary through payroll, subject to FICA taxes, thus reducing your self-employment tax burden. Additionally, you can take non-wage distributions from the profits, which are not subject to payroll or self-employment taxes. However, ensure your salary meets the IRS standards for ‘reasonable compensation’ to avoid unwanted scrutiny.
- C Corporations: Operating as a C corporation involves navigating the realm of double taxation. Pay yourself a reasonable salary to avoid excessive taxes on distributions. Profits left in the corporation are taxed at the corporate rate, and any dividends paid to you are taxed again on your personal tax return. This structure requires careful planning to manage the dual layers of taxation effectively.
Choosing the right way to pay yourself affects your tax liability and influences business growth. Missteps can lead to significant tax consequences, including unexpected audits and penalties.
Review your current business structure and compensation strategy to ensure it aligns with your financial goals and tax planning needs. Keep yourself ahead of the curve in leveraging financial tactics that support your business’s success, subscribe to our newsletter!