Strategies for Distributing Business Earnings to Owner Without Creating Tax Issues
Paying Yourself as a Business Owner: A Guide to Different Business Structures
As a business owner, it's crucial to understand the best way to pay yourself while managing tax implications, legal risks, and financial stability. The approach depends on your business structure, whether it's a sole proprietorship, LLC, or LLC taxed as an S corporation.
Sole Proprietorship
In a sole proprietorship, you pay yourself by taking an owner’s draw from business profits. These withdrawals are not considered a salary. Profits pass through to your personal tax return, reported on Schedule C. You are responsible for paying self-employment tax (15.3%) on net profits, which covers Social Security and Medicare taxes. Since there is no legal separation between you and your business, your personal assets are exposed to liability risks.
LLC (Default Taxed as Sole Proprietor or Partnership)
Single-member LLCs taxed as sole proprietors pay self-employment tax on profits. You pay yourself via owner’s draws—distributions from profits rather than salary. Multi-member LLC owners report profits similarly on their returns and pay self-employment taxes. The LLC provides liability protection, separating personal assets from business risks.
LLC Taxed as an S Corporation
To pay yourself as an S Corp owner, you must put yourself on payroll and pay yourself a reasonable salary subject to employment taxes (income tax, Social Security, Medicare withheld from paycheck). You can also take additional profits as distributions (dividends), which are not subject to self-employment taxes, potentially reducing your overall tax burden. The salary is a deductible business expense, lowering company taxable income. This structure provides liability protection and can improve tax savings compared to sole proprietorship or default LLC status.
The following table summarises the key differences:
| Business Structure | How You Pay Yourself | Tax Treatment | Legal Risks | Key Notes | |----------------------------|----------------------------------------|----------------------------------|------------------------------|------------------------------------------------------------| | Sole Proprietor | Owner’s draw | Self-employment tax (15.3%) | Unlimited personal liability | No payroll; pays taxes on all profit; simple to manage | | LLC (default) | Owner’s draw | Self-employment tax on profits | Liability protection | Single or multi-member; pass-through taxation | | LLC taxed as S Corporation | Reasonable salary + distributions | Salary taxed (employment taxes); distributions exempt from self-employment tax | Liability protection | Payroll required; salary is deductible; distributions reduce overall taxes |
Additional considerations include the need for payroll setup and tax withholdings when paying yourself a salary as an S Corp owner, which establishes proof of income for loans and benefits. Self-employment tax can be a significant cost for sole proprietors and LLCs taxed as such (15.3% combined Social Security and Medicare). Proper tax planning can optimise financial stability and reduce tax burden by choosing the correct structure and payment method. Consulting with a tax advisor or accountant is recommended to determine the “reasonable salary” for your S Corp to comply with IRS rules and maximise tax advantages.
In a sole proprietorship, you pay yourself by taking an owner’s draw from business profits, and these withdrawals are not considered a salary. On the other hand, when your LLC is taxed as an S corporation, you must put yourself on payroll and pay yourself a reasonable salary, subject to employment taxes. This difference in payment methods has potential implications for self-employment tax and tax burden, making it essential to consult with a tax advisor or accountant to determine the reasonable salary for your S Corp and ensure compliance with IRS rules.
