The Different Ways Business Owners Can Pay Themselves

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As an owner, you have a lot of responsibilities. That’s why it’s so important to pay yourself appropriately for all the work you do. But did you know there are different tax implications on the different ways you can pay yourself? In this post, we’ll cover salaries, dividends, loans, and owner’s draw.

Your business entity matters

As a business owner, you can structure your business as a sole proprietorship, a partnership, cooperative, an LLC, a S-Corporation, or C-Corporation.

The sole proprietorship is the most basic type of business entity. All the assets belong to the business owner, but also the liabilities. Because of this, your business is not taxed separately. Instead, your business’s income is your income, and you report it with with a Schedule C and the standard Form 1040.

If you are in a business with one or more partners, you could consider a partnership. Unlike a sole proprietorship, a partnership needs to register with the IRS and state and local tax revenue agencies. A partnership does not pay income tax; instead, the profits pass through to the partners. A partnership files a Schedule K-1 and Form 1065

A Limited Liability Corporation (“LLC”) is a lightweight alternative to incorporate your business. It combines the tax passthroughs of a partnership and the limitations in liabilities of a corporation. An LLC is not taxed as a business entity. Rather, the profits are passed through to the LLC’s members and they are taxed as personal income.

A cooperative is similar to an LLC in that it is also a corporation and does not pay federal taxes. Rather, profits are passed through to the cooperative’s members. A cooperative is different from any other business entity because of its specific rules for membership and operations. Typically, a cooperative’s members must agree on matters like its bylaws and operations in a democratic fashion.

If you’re looking to incorporate your business and have it taxed separately, an S Corporation is a popular choice amongst small businesses. Since the S Corp is taxed as its own entity, a business owner and her employees can see tax savings since they will only be taxed on their wages. An LLC has an option to file as an S Corp for tax purposes. It’s worth noting that not all states recognize the S Corp distinction from a C Corp.

The last business entity option is the C Corp. C Corps are less popular amongst small businesses because of it is more complicated than the other options and typically have costly administrative fees. One of the major drawbacks of the C Corp is the “double taxation.” A C Corp is taxed twice–once when it makes a profit and again when it distributes dividends to its stockholders. However, for many fast growing startups, the C Corp is popular because it can offer stock in exchange for an ownership stake.

How to pay yourself

Now that you know about the different business entities, it’s time to understand all the different ways you can pay yourself, depending on your business entity.

Many business owners are W-2 employees. The W-2 is issued by an employer if the employee earns $600 or more in wages or equivalent. W-2 employees are subject to withholding taxes, which are taken each pay period. A withholding tax is a pay-as-you-go tax to the IRS

and can be calculated through the W-4 and their IRS withholding calculator. These three things determine how much you withhold for your employee:

  • Marital status
  • The number of allowances claimed on the W-4
  • Compensation (Note: This may depend on the State where your employee receives payroll.)

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