When it comes right down to it, the reason we are in business is to get paid. How you pay yourself depends on the type of business structure you have in place.
Sole Proprietor
Compensating yourself when you are a sole proprietor can be as simple as transferring money from the business bank account to your personal account. A sole proprietor is subject to income tax on the net profit of the business. As long as you fulfil all your financial obligations such as taxes, loan payments, etc., the money is yours to do with what you wish.
In a separate article we will tackle the subject of keeping a separate bank account for the business, but it is best practice to move money from the business account into your personal account in order to pay personal bills.
There is no reporting obligation for what an owner pays themself other than the Schedule C as part of the 1040. A sole proprietor does not receive a W2, nor a 1099 from this business. The profit of the business is subject to regular income tax as well as self-employment tax.
All other business structures come with more stringent rules.
S Corporation
Shareholders in a subchapter S corporation receive compensation as employees of the company. One of the requirements of an S corp is that officers who work in the company must receive a “reasonable compensation.” And that compensation comes in the form of a payroll check. With this comes payroll tax obligations to withhold and pay federal tax, state tax, and FICA. The business is also subject to federal and state unemployment tax and may have to pay workers’ compensation premiums.
The rules concerning benefits paid to a shareholder who owns more than 2% of the shares, and related parties, can get complicated. Check with your payroll provider when considering fringe benefits. Distributions of profits of the business can be made to shareholders and must be made in accordance with the shareholders’ percentage of ownership.
As you can imagine, there are rules with govern the taxation of such distributions so it is best to consult your tax professional. Shareholders in an S corporation will receive a K1 and if they perform services, will also receive a W2.
C Corporation
Those who work for a C corporation will also receive a payroll check. Many of the requirements which apply to an S corp payroll also apply to a C corp, though the rules concerning fringe benefits can vary greatly. The profit of a C corporation can be distributed in the form of dividends. Business owners who own stock and work in a C corp will receive a W2 and possibly a 1099DIV.
Partners in a partnership can be paid in a variety of ways. They may or may not receive guaranteed payments for services, or they may receive payments from the profits of the partnership. Partners are not employees. They will not receive a W2. Partners receive a K1 showing the net profit of the partnership and may receive a 1099NEC, and are subject to self-employment tax on their income.
If you have a business and are unsure how to pay yourself, contact our office. We provide payroll services as well as consultations.
If you are behind on your payroll tax obligations, we may be able to help. Contact us to speak with an Enrolled Agent.
Here are links to other blog posts in our Small Business Series: