The method by which you get money out of your business depends on the type of entity you are registered as with the IRS. Here, we’ll go over the different types of businesses and what sets them apart from each other when it comes to paying yourself.
Four Types of Business Entity That Determine How You Pay Yourself:
- Sole Proprietor
- Partnership
- S Corporation
- C Corporation
Keep in mind that a draw, distribution, and dividend all mean the same thing: the dollar amount of profits that have been distributed. In the business world, the term “Owner’s Draw” is linked to sole proprietors, partnerships, and LLCs structured as a single-member or partnership. The term “Owner’s Distribution” is used in association with S Corporations and S Corporation LLCs.
| Entity Type | If LLC Option | W-2 Wage | Distribution of Profits | |
| Single Member Sole Prop | LLC Single Member | No | Yes, only source of income, no W-2 | |
| Partnership | LLC Partnership | No | Yes, only source of income, no W-2 | |
| S Corporation | LLC S Corporation | Yes | Yes, W-2 and Distributions | |
| C Corporation | Yes | Yes, W-2 and Dividends | ||
An LLC can be a Sole Proprietor, a Partnership, or an S Corporation. It can be taxed in three different ways, depending on which entity you select. The entity type will determine how you pay yourself as well as how to distribute the profits back to the owners.
How to Pay Yourself Based on Entity Selection
- Sole Proprietor or Partnership – Draws on profits
- S Corporation – Income Distributions and Officer’s Salaries (W-2/Reasonable wage)
- C Corporation – Officers Wages & Dividends (Double taxation)
Sole Proprietor & Partnerships
If you are a Sole Prop/Sole Prop LLC or a Partnership/Partnership LLC, drawing from the profits of the business is how you pay yourself, and you will owe estimated tax payments on the profits of the business. Since you don’t have a payroll check from the business, your income will not have taxes withheld. Instead, you will owe estimates on the business profits, which are also a factor of all your other sources of income and deductions. For more information on estimates, read our article here.
Pass-through Entities
Sole Props, Partnerships, and S Corporations are all considered pass-through entities. This means that the business itself doesn’t pay income taxes at the business level, the income instead flows over to the personal tax return and you pay the taxes on it personally.
C Corporation Exception & Double Taxation
A “C Corporation” is the only business entity that pays its own income taxes. It will pay taxes on the profit, and when the owner takes a dividend, the individual will pay a tax for the dividend income. This is why very few businesses outside public companies are C Corporations.
Where Most Businesses Start & Where They Land
Today, most businesses start as a Sole Proprietor or Partnership, and once they’re profitable enough they switch to an S Corporation. For information on how S Corporations work, click here.
A reason why some businesses start as a Partnership and stay a Partnership is due to the different tax treatments. For example, Partnerships can distribute profits and losses, have different ownership percentages regarding them, and have an option if one partner is working in the business and the other is a “silent partner.” For more details on which option is a better choice, please contact us.
When a Sole Prop becomes profitable enough to become an S Corporation, the savings become obvious. Where that number range begins can depend on how conservative your accountant is. One question to ask yourself would be: “What would you pay someone else to do what you do?” Usually, when your bottom-line hits 40k-70k a year, the S Corporation conversation becomes relevant. In a Partnership, that range would be slightly higher given you have two partners being paid a reasonable wage.
Spouses & Children
If your spouse or children are working in the business, they can be added to the payroll and compensated. Then, you would need a payroll solution if you don’t already have one in place. This is also done to contribute to a retirement account on their behalf.
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Profitability & Cash Flow
Of course, this question depends on your business being profitable and having the cash flow to pay you. This is where setting sales and profitably goals for your take-home pay is key. Understanding how to do a simple budget, set projections, or quickly calculate your break-even, can make all the difference in understanding the numbers to reach your financial goals.
To learn more about how to pay yourself and distribute profits, set personal financial goals, or pay down debt faster, schedule a complimentary strategy session to help you build the treasure map to your dreams!
