Being your own boss and having the ability to pay yourself is one of the many benefits of being a business owner. Depending on your business structure, you may pay yourself practically anytime. But in some situations, paying yourself as needed isn’t a smart idea, especially when it comes to maintaining your asset protection status or settling taxes.
Paying yourself in a sole proprietorship
If you operate a sole proprietorship, you have the most flexibility about paying yourself. You can take draws whenever and at any amount you want. Just make sure not to overdraw the business account. It’s best to keep your withdrawals to a minimum at the start. That way, you don’t accidentally spend the profits needed to keep a good business cash flow.
Since sole proprietorships are simply extensions of the business owners, they aren’t taxed like other business entities. No payroll taxes are also deducted since you don’t pay yourself a salary. But even though you’re not technically employed, you must still meet the periodic tax payment obligations set by the IRS. So it’s crucial to track all the payments for yourself, so you can leave a portion to settle your taxes quarterly or annually.
Paying yourself in a partnership
Like sole proprietorships, general partnerships are not separate legal entities. They aren’t taxed at a separate rate. And the income that the partners earn from their business is often included on their individual income tax returns.
Technically, partners can draw funds from their business as they please. But, of course, that can come with certain complications, especially if one partner is allowed to withdraw funds in larger amounts or more often than the other partners. To avoid such issues, be sure to create a general partnership agreement that specifies payment details for each partner.
How about paying taxes? Like sole proprietorships, general partnerships also have to meet periodic tax payment obligations. Keep in mind that you have to pay taxes on the business profits, not just the draws you made throughout the year. So be sure to leave a portion for taxes from every payment you make to yourself to be more prepared during tax season.
Paying yourself in an LLC
Unlike sole proprietorships and general partnerships, LLCs are separate legal entities. They can also choose how they want to be taxed. If your LLC is under the default classification and has not elected to be taxed as a corporation, you can’t receive a salary from your LLC. You can withdraw amounts from the business as necessary. Monitor and document these withdrawals, as you’ll need to report them on your individual income tax return.
Similar to sole proprietorships and partnerships, LLC members in the default classification are usually taxed on the company’s entire profit, not only what they withdraw from the business account. So, make sure to keep that in mind when preparing for tax payments.
Paying yourself in an S corporation
If your LLC has elected to be taxed as an S corporation, you must pay yourself through salary. You must choose a reasonable annual salary to meet IRS requirements. But at the same time, you want to ensure your owner’s salary won’t cripple your business operations.
According to the IRS, the “reasonable salary” for S corporation owners must be an amount that would usually be paid for similar services by similar organizations in similar circumstances. Simply put, you need to benchmark your salary using the salaries of owners of companies like yours. Otherwise, you may face tax penalties and negligence fees, especially if you disguise your salary as dividends or non-taxable shareholder distributions.
Paying yourself in a C corporation
Did your LCC elect to be taxed as a C corporation? You basically have similar tax requirements as an S corporation. Your company must also pay you a reasonable salary. The only difference is the dividends from a C corporation are taxable. At tax time, C corporation owners must file their corporate tax returns as well as their personal tax returns.
Consult with us.
If all these details seem overwhelming, let our team of experienced accountants help you. We’re here to guide you through your tax requirements. Contact us to book a consultation.