The age old question we receive from many small business owners - can I put myself on payroll? A valid question at that because most entrepreneurs transition from being employees for other businesses, where receiving a paycheck was the norm. How to pay yourself as a business owner isn’t based on what you’re used to, or what’s easiest – it primarily depends on your business structure (but like most things in entrepreneurship and in life, there are always some other factors too).
Before we get started though, let’s define the word salary for the purposes of this article. A ‘salary’ assumes the following:
Payroll taxes (federal and state, if applicable) will be withheld.
Most often, payroll software will be used to process payroll, although it can be done manually.
At the end of the year, the wages paid and the taxes that were withheld (and ultimately remitted to the IRS and state, if applicable, will be reported on a W2.
The word ‘salary’ will not be used to describe any other form of pay.
Got it? Perfect! Let’s get started.
As a sole proprietor, you don’t pay yourself a salary and you can’t deduct your salary as a business expense. Technically, your “pay” is the profit (revenue minus expenses) the business makes at the end of the year. When you do pay yourself, we recommend that you do so in a way that can be documented and is used consistently. That could be writing a check to yourself for the amount of money you want to withdraw from the business and categorizing it as owner’s draw (equity account) and deposit into your personal checking or savings account. You can also pay yourself via a transfer from your business account to your personal account. Do your best to avoid the commingling of funds that comes from using your business account to pay for personal expenses. Remember, this is “profit” being withdrawn, not a salary. Therefore, no income taxes, self-employment taxes (Social Security and Medicare tax), or state tax, if applicable, will be withheld from what you pay yourself. Ideally, you’ll make estimated tax payments throughout the year to pay the IRS and state (if applicable) the income and self-employment tax you anticipate owing at the end of the year. If not, you will have to pay those taxes when you file your personal tax return, so remember to set aside money to cover the outflow of cash.
The IRS views single-member LLCs as “disregarded entities,” meaning that for tax purposes, the owner and the business are one and the same. So what does that mean? Your LLC profits are considered personal income rather than business income, just like a sole proprietorship. Single-member LLCs pay themselves through what’s known as an owner’s draw (just like the sole proprietor). The amount and frequency of these draws is up to you, because regardless of what you pay yourself, you’ll pay tax on the business’ profit, not just what you paid yourself.
Multi-member LLCs, classified as partnerships, are treated as “pass-through entities” by the IRS. This means that although business income must be officially reported to the IRS (and state, if applicable), the business itself doesn’t pay tax. Instead, the partnership tax return is filed to split the profit or loss between the members/partners, so that each member can report their share of the profits on their personal tax return, and pay tax on their portion of income from the business. . Much like single-member LLCs, multi-member LLC members also pay themselves through the draw method (typically it’s an equity account called ‘member’s draw’ since there’s more than 1 owner. Members can also be paid via guaranteed payments depending on the type of work they perform within the partnership, but the way in which taxes are paid (via the personal tax return) remains the same.
Corporations If you operate as an S-Corp or C-Corp for tax purposes, members or shareholders aren’t allowed to take owner’s draws. Instead, they're considered employees and must pay themselves a salary on the company’s regular payroll with taxes withheld. You can determine your salary amount, but that figure must meet the requirements for “reasonable compensation." The IRS defines this as “the value that would ordinarily be paid for like services by like enterprises under like circumstances.” As a shareholder of an S-Corp, once you’ve been paid reasonable compensation, you can also pay yourself distributions which aren’t subject to self-employment tax.
Pay can get confusing especially as your entity needs evolve - let ASE Group help. We can determine the most efficient and legal way to pay yourself while minimizing your tax liability!