Business owners are hard-working and dedicated. They put in probably sixty plus hours a week. It is natural that they want to get paid for their time that they pour into their small business. Unfortunately, if it is a new start-up company, it probably isn’t making enough income yet to see a payday. If the business has been in operation for a while though, the bank balance might be increasing each month as profits start to accumulate.
So, how do business owners get paid? Are they considered employees?
Well, the answer to the question above is – it depends. Clear as mud, right?
It all depends on how the small business is legally setup and recognized by the Internal Revenue Service. Most businesses that are relatively new are small enough that they are operating as sole proprietors or as a partner in a partnership. That means that they haven’t incorporated under state law.
There is good and bad news when a small business is operating as a sole proprietor or a partner:
- The good news is that payday for the business owner can be any day they feel like paying themselves as long as there is enough money in the bank. They just simply write themselves a check. They aren’t considered an “employee”, because they are a “one-man-show” running the business. The Internal Revenue Service sees the owner and the small business as one entity.
- The bad news is that they are not recognized as an employee and no federal taxes are being withheld from their pay. So when April 15th comes around and it is time to file the income tax return, the owner may owe quite a bit of self-employment tax on the profits of the business. That is why owners should pay quarterly self-employment taxes throughout the year if they think they are going to owe at least $400 or more in tax.
If the small business is recognized as a corporation or S corporation, it needs to set the owner up as an employee of the company and pay them a set salary or wage that is similar to what other organizations pay a person with the same skills. Payroll taxes will be withheld from the owner’s pay just like any other employee.
As an S corporation, the owner can also make draws or distributions if the business is making a profit, but no tax is withheld from these payments and it is best to talk with a tax advisor before doing so. There are limitations as to the amounts that can be taken out of the business account in this manner.
Hopefully this has answered the question of “How do I pay myself?” It can be tricky determining what the rules are regarding paying the owner of a small business. Consulting with a Certified Public Accountant is always a wise decision when setting up procedures for the organization.