How you pay yourself as a business owner depends largely on your business’s structure. Sole proprietorships and partners can just take money from the business account, but S Corporation (S-corp) and C Corporation (C-corp) owners must pay themselves for any services performed through payroll.
- Sole proprietorship can pay themselves using an owner’s draw without any tax consequence.
- Partners can receive partner draws without paying taxes.
- S-corp and C-corp shareholder-employees must receive wages and pay payroll taxes for services performed.
- S-corp shareholders can receive distributions of profit with no tax effect as long as the payment isn’t for services.
- C-corp shareholders can receive dividends and pay tax on them at the long-term capital gains rate as long as the payment isn’t for services.
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How To Pay Yourself From a Sole Proprietorship
If you are a sole proprietor, you can simply pay yourself from the company’s bank account. This is called an owner’s draw, and it has no effect on your taxes. You’re required to pay income and self-employment taxes on the net income shown on your schedule C, regardless of whether you take an owner’s draw.
If you require assistance with your Schedule C, our article on how to fill out your Schedule C will walk you through the process.
When making a payment to yourself, you have the option of writing a check to yourself from your business bank account or electronically transferring the money into your personal account. On the memo line of the check, write “Owner’s Draw” in case there is any question what the payment was for in the future.
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After paying yourself, the next step is to record the draw in your company’s books in what is called a drawing account. The process of recording the check is the same as when you write checks to vendors, except instead of assigning an expense account, you’ll assign the check to an equity account called “Owner’s Draw.”
Before writing the check, make sure your chart of accounts includes the “Owner’s Draw” equity account. If you’re using QuickBooks Online, you can see our guide on how to set up your chart of accounts in QuickBooks Online.
Your draw comes from your equity in the company and, as such, this will not count as an expense on Schedule C. Owner’s Equity is the book value of all your company assets less any liabilities the company owes. Therefore, when you take cash out of your company, your equity decreases.
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How To Pay Yourself From a Partnership
If you operate a business as a partnership, you are permitted to withdraw funds for your own use from the company’s bank account with what is called a partner draw. Whether the draw is a discretionary payment to you or a guaranteed payment, writing and recording the check is the same. The only difference will occur when you allocate company earnings among partners on the Form 1065 tax return. For guidance, see our Form 1065 step-by-step instructions.
A guaranteed payment is the minimum amount the partnership must pay you, irrespective of the profits the partnership has made. Your partnership may have agreed to these payments by either paying a certain percentage of money or making certain periodic payments.
If you want to pay yourself, you can write a check to yourself from your partnership’s bank account. You can do it just like you would write a check to someone else. You also have the option of making an electronic transfer to your bank account from the partnership’s bank account.
Just like with sole proprietors, you’ll want to assign the check to an equity account instead of an expense account. The equity account should be named something similar to “Paul’s Draw”—except use your name instead of Paul. Each partner should have their own drawing account.
After paying yourself, you need to record the draw on your partnership’s books by entering a check and assigning it to your draw account. Since a draw reduces the value of the partnership’s equity, it will not show up as an expense on Form 1065.
How To Pay Yourself From an S-corp
If you operate an S-corp, you can pay yourself a salary, take a distribution, or receive both.
If you perform services for the S-corp, then you are an employee in addition to an owner. The S-corp is required to pay you fair compensation for your services before any cash paid can be classified as a distribution instead of wage or salary. This means you will have to pay yourself a salary that is comparable to the standard in your industry for the amount and type of the services you performed. If the IRS determines that your salary is too low, then you could be penalized.
If you’re unsure how much you should pay yourself, you can take a look at the United States Bureau of Labor Statistics’ Occupational Employment and Wage Statistics. There, you’ll find statistics on over 800 industries.
After receiving a fair wage or salary, you may receive a distribution of retained earnings from the corporation. If you are the only shareholder, then you can set your distribution as whatever you please. If there are multiple shareholders, then each shareholder must receive their fair share of the distribution amount based on how much stock they have in the company.
If distributions are not paid evenly to all shareholders based on their ownership percentage, the IRS can revoke your S-corp status and tax you as a C-corp.
If you receive wages from your S-corp, they have to be processed through a payroll system and are subject to Social Security and Medicare taxes (also known as FICA).
For S-corps, wages represent an expense to the S-corp and an income to the owner. When you record wages, the amounts offset each other, so there is no effect on total taxable income from the S-corp. However, the wages increase the total taxes paid because they are subject to payroll tax.
If you receive a distribution in addition to any wages, the check can be written from your S-corp bank account. You can either write a check to yourself or electronically transfer your distribution from your company’s bank account to your personal checking or savings account.
How To Pay Yourself From a C-corp
If you own and operate a C-corp, you can pay yourself wages, take a dividends distribution, or receive both forms of compensation.
For C-corps, any owner distributions must be paid to all owners ratably based on ownership percentage and are called dividends. As with S-corps, C-corp owners must pay themselves a fair wage as employees for any work they perform for the corporation.
When you receive a salary from your C-corp, the salary is a deduction to the corporation and income to you. You must process your salary through a payroll system, and it will be subject to payroll taxes. If you are looking for a system that works best for your business, check out or article best payroll software for small businesses.
Any wages paid should be commensurate with the duties performed. If the IRS believes that any wages that you have paid yourself are excessive, then it may reclassify your wages as a dividend distribution.
If you want to pay yourself an additional amount of money on top of the salary you receive, you can distribute dividends to yourself along with all the other shareholders. With dividends, you do not have to run payroll, you can simply write a check to yourself or you can initiate an electronic transfer from your business account to your personal checking account. As with S-corps, it’s required that all C-corp shareholders receive their pro-rata share of dividends based on ownership percentage.
After you have taken your dividends distribution from your corporation, your distribution should be recorded as equity and not as an expense to the corporation. Dividends are not deductible to the corporation, but income to the shareholders. .When you receive your dividend as an individual you will pay long-term capital gains tax on the distribution. The C-corp is required to report all dividends paid for the year on IRS Form 1099-DIV filed with the IRS and mailed to each shareholder.
Frequently Asked Questions (FAQs)
No. If you have yet to earn enough money, you can keep your money in your business account until the business becomes profitable.
C-corps are not required to issue dividends. However, not paying dividends when profitable might draw additional scrutiny. The IRS may decide that some of the salaries you pay to owners are dividends. Consequently, the IRS may disallow some of your previous salary deductions and reclassify your previously taken salary as dividends.
If you do not pay yourself a salary or issue dividends to yourself, the IRS could find that you have accumulated earnings, and you could face the 20% accumulated earnings tax. The best way to defend against the accumulated earnings tax is to document business plans that justify the accumulation of earnings. For instance, you might be accumulating earnings to build a new factory.
As a small business owner, knowing when and how to get money out of your business is essential. Each payment method comes with its own unique tax and accounting methods. Be sure you understand the rules before issuing yourself a distribution or paying yourself wages.