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How Do I Pay Myself?

To someone who doesn’t own a small business, this sounds like a strange question. But to my super-sonic CPA ears, this is a very familiar inquiry made on multiple occasions each year as we meet and strategize with start-ups.

I have come to realize that the question isn’t really “how do I pay myself,” but more “how is my compensation treated for tax purposes?” Let’s take a quick look at that question, as it pertains to self-employed individuals and corporate shareholders.

Self-Employed Schedule C Filers:

  • If you’re self-employed, you are not on payroll. Let me say that one more time because it bears repeating…you’re NOT on payroll.
  • You compensate yourself by taking owner draws (or member draws, if you are self-employed and operate as an LLC), which are similar in spirit to payroll, but are not payroll.
  • Since IRS considers your business and you to be one entity, you pay self-employment and income taxes on the net income of your business, not based on your owner draws.
  • Also remember that owner draws are not tax-deductible since they’re not considered payroll. Your profit is considered to be your compensation; self-employment taxes are your payroll taxes.

Partnerships:

The compensation issues within a partnership are complex, and beyond the scope of this light-hearted blog post. I’d recommend that you make an appointment with a professional who works with partnerships and ask your questions there. Of all the compensation misunderstandings I have dealt with, most of them come from partnerships.

Corporate Officer/Employees:

  • If you are the shareholder of an S-Corporation or C-Corporation, you are required to be on payroll if you provide services to the business.
  • Payroll is tax-deductible for the corporation and is taxed as ordinary income to the shareholder.
  • My advice for a start-up is to commit to payroll at some point in time when there is enough available cash flow to do so. We advise a client to set the shareholder’s salary at an amount that can be paid each month without fail. That way, it’s easier to budget for the cash outlay for payroll and payroll taxes.

Business owners misunderstand payroll on many levels. In the self-employment world, draws are not considered payroll. In the corporate world, it’s a requirement for the shareholder/employee. No matter the entity, compensation is a planning tool and should be regarded with the power it possesses.

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