The ability to control your own salary is likely one of the things that drew you towards becoming a small business owner in the first place. Unfortunately, things can get complicated when it comes time to pay yourself. We explore some of the best ways to go about that in this blog.
Start by Choosing the Right Business Category
If you operate as a sole proprietor or as part of a business partnership, the Internal Revenue Service (IRS) does not allow you to receive paychecks from the company’s payroll. Although you can use company revenue to pay yourself, remember that any money you transfer to your own bank account is taxable.
For sole proprietors and business partnerships, the ideal solution is to request distributions and then make quarterly estimated tax payments. Be sure to set aside at least 15 percent of your net profits so you don’t have a surprise tax bill when you file your annual return. To make things easier for your accountant, consider establishing a regular schedule of distributions. Taking this approach also makes it easier to budget for your own personal expenses.
Limited liability corporations operate under state tax laws, not federal ones. Check with your state taxing authority for instructions on paying yourself and filing a business tax return.
Corporation owners can receive funds through their own company’s payroll system and receive a W-2 statement at the end of the year. You can claim your own salary as a business deduction as well.
Like standard corporations, you can request tax-free distributions from company revenue when you operate a C corporation. If you choose this option, the IRS requires you to withdraw an amount it considers reasonable. The IRS definition of reasonable is that you receive close to the same amount of compensation as other business professionals in similar roles. Keep in mind the IRS taxes any distributions you receive.
Owners Draw vs. Salary
Since sole proprietors, members of business partnerships and limited liability corporations meet the IRS definition of self-employed, they do not receive their income in wages as typical employees and owners of corporations do. Instead, they take distributions, also known as an owner’s draw. Although you don’t pay tax at the time of the draw, you will need to do so when you file your business tax return.
The IRS requires corporation owners to take a salary instead of a draw if you play a pivotal role in the daily operations of your company. You then receive a W-2 statement at the end of the year and file your business return like typical employees.
Remember that you cannot withdraw any amount you want because it must meet the IRS definition of reasonableness. Take the time to review your company’s profit and loss statements to determine how much you can afford to pay yourself under IRS guidelines.
Contact Us to Learn More About Business Owner Payroll Options in 2021
With a fresh new year upon us, now is the perfect time to get your payroll in shape for the upcoming year. Please contact Palmetto Payroll to learn more about our services today.