Paying yourself should be one of the perks of owning a business. You make the money, write yourself a check, and you’re done. Except the IRS doesn’t see it that way. How you pay yourself depends on how your business is structured, and if you get it wrong, it’s going to cost you.
Are you Actually an employee?
As it turns out, owning the place doesn’t automatically put you on payroll. Before you decide how to pay yourself, start with one important question: are you an actual employee of your business?
If you’re a sole proprietor, the answer is no. Partners generally aren’t employees of their partnerships, either.
Corporations are different. Corporate officers who perform services for the business and get paid (or are entitled to payments) are generally employees.
Not every payment is a paycheck
So, if you’re not an employee of the business, how exactly do you get your money without feeling like you’re stealing from your own business?
Sole proprietors can just take the money out of the business for personal use. The IRS treats that as a personal withdrawal, not deductible wages. And here’s the kicker: you’re taxed on the business’s profit whether the money makes it to your personal account or not.
Partners can receive distributions and guaranteed payments (in some cases). Those aren’t employee wages, either.
This sounds convenient and all, but there’s a catch. There’s no employer withholding taxes from your payments, so you may need to make estimated tax payments and pay self-employment taxes. Just another perk of being the boss.
Then, if you aren’t confused enough, add LLCs to the mix.
- Single-member LLCs are treated as sole proprietorships by default for federal income tax purposes.
- Multi-member LLCs are treated as partnerships by default.
- LLCs can also elect to be taxed as a corporation (including as an S corp).
How you pay yourself depends on how your LLC is taxed, not just the fact that you have an LLC. Did you really think the IRS would make it that easy?
But for some business owners, an actual paycheck is required – and you don’t get to just pick a random number to pay yourself.
Find out when the IRS gets a say in your salary.
Get more articles like this straight to your inbox 
Free as a meme, easy to bail anytime.
S corps don’t get to skip payday
S corp owners, listen up. This is where the paycheck is non-negotiable.
If you’re a shareholder-employee who performs services for your business, you generally need to pay yourself reasonable compensation before taking non-wage distributions. In other words, you can’t give yourself a suspiciously small salary, take the rest in distributions, and pat yourself on the back for your ingenious tax-saving idea.
Nice try, though.
Why does the IRS care? Is it deeply invested in your financial well-being? We wish. As you could probably guess, it all comes down to money – as in, what you have to pay in taxes.
Wages are subject to employment taxes. So, it’s no surprise that it’s a no-go to pay yourself $10,000 in wages and take $90,000 in distributions when you’re doing most of the work.
And if you think you can pull a fast one on the IRS, well, think again. The IRS can reclassify distributions as wages if it determines you weren’t reasonably compensated. So, that money you thought wasn’t wages? It is wages after all, with the employment tax bill that comes along with it.
Then what counts as reasonable wages? Here comes your favorite tax answer: it depends. There’s no universal salary or percentage that works for every S corp owner. The IRS looks at factors like your duties, experience, time spent working for the business, and what comparable businesses pay for similar work.
Basically, the more important you are to running the business, the harder it’s going to be to explain why you’re earning less than your summer intern. So, don’t run to a Reddit thread, a TikTok video, or your brother-in-law to figure out your compensation strategy. Your salary should make sense for the work you actually do.
There’s no single answer for how to pay yourself as a business owner. And you don’t have to memorize the tax code. You just have to know how your business is taxed and which payday rules apply to you. If you get that part wrong, you could be looking at back payroll taxes, penalties, and interest.
And if you truly don’t know, ask a tax professional before payday. Clearing the confusion up now is a heck of a lot easier than cleaning up the mess later.
