One of the most rewarding moments in owning a successful business is paying yourself for your hard work. Two of the most commonly asked questions I get from business owners are "How do I pay myself?" and "If I transfer money to myself, is it taxable?". The answer can vary widely depending on how your business is set up. Here are some general best practices to pay yourself depending on your business setup.
Sole Proprietor & Single Member LLC
This is the most common setup, especially among new business owners. Paying yourself while as a Sole Proprietor or a Single Member LLC (SMLLC) is very simple.
Money can be transferred directly from your business bank account (You have a separate bank account for your business, right?) to your personal checking account. In the accounting world, this is called "taking a distribution". There is no need to set up payroll or even make scheduled payments. There is also no requirement to take a distribution at all. The income earned as a Sole Proprietor is taxed the same regardless of how much is withdrawn.
Need more info? Here are 5 things to consider when paying yourself as a sole proprietor.
S-Corporation
If your business is structured as a S-Corporation (S-Corp) paying yourself is a bit more complicated. If you are withdrawing money from a S-Corp as a business owner, you must also pay yourself a "Reasonable Wage". Determining an amount for what is a "Reasonable Wage" is a key area for tax planning. Included in our subscription package is a "Reasonable Compensation Study". The purpose of this study is to determine a wage of which can withstand scrutiny from an IRS audit. Once a wage amount is determined, the business owner will need to pay themselves a wage as an employee of their business.
Once you have paid yourself a reasonable wage, a business owner may withdraw money from the business as a nontaxable distribution. Distributions are neither taxable to the business owner or deductible to the business. However, owners should be cautious of withdrawing money beyond their basis in the business. Distributions in excess of basis are subject to capital gains tax. This is another great area for tax planning. A tax professional can help determine ahead of time if withdraws could be subject to capital gains tax.
C-Corporations
Pulling money out of C-Corporations (C-Corps) can be difficult but not impossible. The easiest way to pay yourself is by paying yourself a wage as an employee. Non-wage distributions are taxed based on many variables but assuming your business is overall profitable*, the distribution will most likely be taxed as a dividend to the receiving individual.
The dividend distribution is taxable to the individual but is not deductible to the C-Corp. The distribution is essentially taxed twice, this is known as "Double Taxation". A tax professional can help you avoid double taxation by creating and implementing a strategy in your business.
Paying yourself from your business can be a rewarding experience. You worked hard to be sure your business is profitable and you earned that paycheck! A tax professional can help you get the most out of your business while also avoiding surprises come April.
If you would like to see how we can help you in your business, schedule a virtual consultation to speak with a tax professional.
*Please seek the advise of a tax professional to determine your specific situation.