Question: Business Owner Salary and Distribution of Profits - Your Questions Answered
How do I take a salary from my business?
The word "salary" is common when talking about employees, but most business owners don't actually take a salary as an employee. In order to discuss how to pay yourself as a business owner, you must first look at the legal structure of your business:
- If you are a sole proprietor you are not an employee and you don't take a salary in the form of a regular paycheck. No FICA taxes (Social Security/Medicare) are deducted and no federal or state income tax is withheld. A sole proprietor gets "paid" by taking a distribution from the profits of the business. Amounts taken out of a business by a sole proprietor may be called "draw," because these amounts draw down your capital (ownership) account. Read more about how owner's draw works.
- A partner in a partnership also does not get paid a specific salary. Partners can take distributions from partnership profits and are taxed based on their share of those profits on their partnership income tax return. How profits are distributed in a partnership or LLC depends on the language of the partnership agreement or LLC operating agreement.
- Owners of limited liability companies (LLCs) (called "members")are not considered employees and do not take a salary as an employee. Single-member LLC owners are considered like sole proprietors for tax and income purposes, and multiple-member LLC members are considered like partners in a partnership.
- An owner of a corporation or s corporation is a shareholder, but corporate officers (those who work in the business) must take a salary and employment taxes must be paid on that salary. In addition, S corporation shareholders may take additional distributions of profit from the business.
How much salary can I take as a business owner?
Business owners (other than corporate officers) can take any amount they want from their business. Of course, you shouldn't take money that will be needed to pay employees, pay off business loans, or pay other bills of the business. The SBA has some tips for setting your salary as a business owner.
What's a reasonable salary for an officer in a corporation or s corporation?
Some corporations try to hide corporate officer pay to avoid employment taxes, but the IRS says corporate officers must be paid a reasonable amount. The IRS has established guidelines for determining a reasonable pay, based on experience, duties and responsibilities, time spent, comparable amounts paid to others doing similar work, and other factors.
How does self-employment tax work for business owners?
Self-employment tax is the equivalent of FICA tax (Social Security and Medicare)for business owners. The amount of self-employment tax that must be paid is based on the profits of the business; if the business does not make a profit in any one year, no self-employment tax is due.
Owners of sole proprietorships, partnerships, and LLCs do not take a salary, so money they take from the business does not have deductions or withholding for (1)FICA taxes (Social Security and Medicare), (2) federal income tax, or (3) state income tax. In addition, no other employment taxes are paid by the company for this distribution to a business owner.
Sole proprietors, partners, and LLC members must pay self-employment tax when they complete their personal tax return for the year. The self-employment tax is calculated and added to the income tax due; self-employment taxes are paid to the IRS along with federal income taxes.
How does income tax get deducted from payments to business owners?
Since payments to business owners (not including salaries to corporate officers) are not considered payroll, federal and state income taxes are not withheld. Business owners must make quarterly estimated tax payments to avoid penalties.