Owning a business is a remarkable accomplishment. Being an entrepreneur comes with a large amount of responsibility; specifically, when it comes to your financials. Paying yourself as an entrepreneur is not a complicated topic, but it does need to be done correctly. The structure of your business determines how you can pay yourself.
Sole Proprietor
If you are the only owner of your business, you are considered a sole proprietor. As a sole proprietor, you would pay yourself by simply transferring funds from the business bank account to your personal bank account. These are called owner’s draws and they can be done at any time. As a sole proprietor, you are taxed on your net income whether you take the money out of the bank or leave it in. In other words, taking the money out is not additional income nor is it a deduction.
Partnership
If you and another person are in business together then you are considered a partnership. To compensate each partner for your contributions per the partnership agreement, you both will receive what is called guaranteed payments. Guaranteed payments are like getting a salary but with no taxes withheld. Cash can be transferred directly from the business bank account or by cutting a paper check to the partner. Guaranteed payments are only taxable to the partner receiving them and the partnership gets to use it as a tax deduction.
C Corporation
If your business is structures as a C Corp, there are two ways to compensate yourself for your services. One is by receiving a salary through payroll and the other is by receiving dividend payments. As a shareholder of a C Corporation, you are allowed to be on payroll, although not required, it is expected if any payments of cash are transferred. Salaries are tax deductible by the C Corporation, dividends are not tax deductible. Both salaries and dividends are taxable to the shareholder receiving the cash.
S Corporation
When your business is structured as an S Corp, as a shareholder, you must pay yourself a reasonable salary. How much would you pay someone else to do the exact job duties you are doing? Salaries are tax deductible by the S Corporation and taxable to you the shareholder, i.e. the employee.
In conclusion
There are other ways of taking cash out of your business that we will talk about in next week’s blog. Before making any big decisions, we always recommend talking to a qualified tax professional – preferably one who knows your business already. They will help guide you to make the best decision for your business.
How do your books look, specifically your QBO? Do you have tax strategies in place for 2021 and 2022? Are you prepared for the upcoming tax law changes build into the new bills being passed? These are all things you need to be asking yourself as we begin closing out 2021.
If you are an online entrepreneur looking to get freedom from the accounting, tax, and regulatory aspects of your business, CPA On Fire can help. CPA On Fire has ample experience helping online entrepreneurs grow exponentially in their business. Let’s connect and we’ll show you how we can help you.