Paying Yourself from Your Business
Owning your own business can be very rewarding. (It is also very time consuming!)
But many people do not understand exactly how they get "paid" from their business.
We summarize that important issue here, but it all depends on what form of
business you have. There are four choices:
- Sole Proprietorship
- Partnership
- Corporation with S-Chapter election (S-Corp)
- Corporation without S-Chapter election (C-Corp)
What about the Limited Liability Company (LLC) you ask? Depending on the ownership
and filing of an LLC it files taxes as one of the above.
Sole Proprietorship
This is the easiest type of businesses to form. It also has the simplest bookkeeping requirements.
This type of business does not file a separate tax return; the profit or loss is simply
filed as part of the owner's tax return. Therefore, there is nothing specific in paying
the owner. The owner simply takes money out of the business as desired (and available!).
The important point is that the owner is NOT an employee. So there is no payroll for the
owner, and no withholding, and no W-2. The owner must pay Self-Employment Tax in addition
to income taxes. The 14.13% SE tax is in place of the 15.3% FICA otherwise paid.
Partnership
A Partnership is fairly easy to form, and maybe the easiest for multiple owners who are
not married. But a Partnership has the most difficult bookkeeping requirements.
Like a Sole Proprietorship, the owners of a Partnership are not employees, do not receive
paychecks with withholding, do not receive a W-2, and are subject to Self-Employment Tax instead
of FICA. They can remove money from the Partnership as long as it is consistent with
the partnership agreement, and they have the "basis" to allow for the withdraw.
When a Partnership desires to make disproportionate payments based on business activity,
that is done through the Guaranteed Payment provisions of a Partnership.
When it comes time to file taxes, the Partnership files a special Partnership tax return
that does not include any tax. But the return does include a K-1 (1065) for each partner,
showing the partner's share of profit or losses. This transfers the partner's share
of profit or loss into their own personal tax return, where the taxes are determined.
S-Corp
This is a corporation that elects to file taxes as a "pass-through" entity.
This means that at the federal level it does not pay taxes, but transfers its profit
or loss to the owners through a K-1 (1020S) similar to a Partnership.
(California does assess a state income tax on the S-Corp.)
The owners of an S-Corp, presumming they are involved in the business, are
employees. This means they must receive a paycheck, and that paycheck should
include withholding of income taxes and FICA. (The S-Corp pays the employer's
portionm of FICA just like other employers.) The owners will also receive a W-2.
Generally there is excess profit over and above the salaries or wages paid.
This can be distributed to the owners in a consistent manner and is not a taxable
event providing that the owner has the "basis" for the distribution. The taxes
on this excess are determined on the individual owner tax return, having arrived
through the K-1 (1120S).
C-Corp
This form of business is the most familiar type of employer, and owners are not
treated any different than any other employee. They receive a paycheck with withholding
for income taxes and FICA. They receive a W-2 just as other employees.
Any excess income is retained by the corporation where it pays its own income
taxes. Income can be distributed to owners through stock dividends, where it will
be taxed again. Thus a C-Corp type of business results in double-taxation for
the owners.
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