How Should I Pay Myself?
You have worked hard to grow this small business and just look at the fruits of your labor! You’ve done well! How much of the profits should you be paying to yourself? There are several things to keep in mind.
Each business structure has different tax implications. How much do you need to set aside for taxes? How is your business structured? Knowing the best way to pay yourself could mean THOUSANDS more per year in your pocket!
As a sole proprietor, you can only pay yourself one way: by writing yourself a checking or transferring money from your business to your personal bank account. Sole proprietors are not eligible to be set up as salaried (W-2) employees under their business, so distributions are currently the only option.
However, please make note of three important facts:
1. No matter how much you pay yourself, you are always taxed on how much PROFIT your business makes in a given year. So even if you only pay yourself $30,000 of the $55,000 your business earned, you still have to pay tax on the full $55,000.
2. You not only have to pay federal and state income taxes on that profit, you also have to pay self-employment tax, which is about 15%.
3. Those distributions you pay yourself are not tax deductible so they cannot be listed as an expense. Instead they reduce the amount of equity you have in your business.
LIMITED LIABILITY COMPANY/PARTNERSHIP
As the owner of an LLC, you can pay yourself through distributions, guaranteed payments, or, if you actively work in the company, a salary.
Guaranteed payments are specific amounts guaranteed to be paid to a member of the LLC regardless of whether the business is running a profit or a loss. They are deductible as an expense to the business and must be included as income for the owner receiving the payment (meaning they, too, are subject to income and self-employment taxes).
Before you set yourself up with a salary, understand: Any wages, payroll taxes, benefits, etc. are able to be expensed through the business; however, you will incur additional expenses: Employers (even if you are only employing YOU as a W-2 employee) must pay their own portion of FICA taxes AND unemployment insurance for both federal and state.
In other words, you’re going to incur another expense, which is why most people typically don’t pay themselves as a salaried employee unless they are ready for S-Corp status.
The biggest pull to structuring your business as an S Corp is to take advantage of the benefits around paying yourself a salary, which is a requirement for owners under this structure. Paying yourself a salary is good for one reason: Social Security. When you are a W-2 employee, you get on their radar, meaning that you will receive benefits once you hit retirement age.
Now for the bad news: In all other business structures, when you pay yourself a salary or a distribution, you not only have to pay the employee portions of FICA taxes but you also have to pay the employer portion, too. Combined, these come out to about 15% of your income.
However, as an S Corp, while you have to pay yourself a “reasonable” salary for your role in the business, any additional distributions you pay yourself are NOT subject to self-employment tax, meaning you automatically save 15% on those distributions.
So, if you were paying yourself $80,000 under the LLC structure, you’d have to pay $12,000 in self-employment taxes. In an S-Corp, you need to determine a reasonable salary for what you do. Let’s say you pay yourself a $40,000 salary, which results in a $6,000 self-employment tax liability. The remaining $40,000 can be paid to you as an additional distribution with no self-employment tax.
Let’s hear it for some savings!
In a C Corporation, you must pay yourself via a salary OR dividends, which is kind of like a distribution.
However, note with dividends that they have to be paid evenly across all owners of the same classification of shares. So if you structure yourself under this entity-type with three partners and you all have the same amount and type of shares, you cannot pay yourself more or less than the others. If you’re actively working in the business, it’s best to set yourself up as a salaried employee and take dividends as a bonus.
Now that you are more informed about paying yourself, be sure to reward yourself for a job well done! You’ve worked hard and you’ve earned your keep! Enjoy the fruits of your labor.