What’s the Best Way to Pay Yourself?

If you operate a business where you’re responsible for paying yourself, you’ll probably have to choose between two business structures: a limited liability company (LLC) and an S corporation. These are both considered to be pass-through entities, meaning they pass the business’s profit or loss through to the individuals who pay taxes on it. However, LLCs have more flexibility when it comes to management and ownership, while S corps have more favorable options when it comes to getting paid and paying taxes.

We’ll go over the ins and outs of LLCs and S corps so you can make an informed decision about which option is best for you.

LLC

A limited liability corporation (LLC) is a hybrid business entity that protects its owners from being personally liable for the business’s debts. An LLC is considered to be a flexible business structure since the owners determine how to operate the LLC and members can decide if owners or managers run the company.

Tax Treatment

An LLC is a pass-through tax entity, which means business income flows straight to the owners, who report it on their personal taxes at the end of the year. This can prevent income from being double-taxed since only the individuals, not the business, pay taxes on the profit.

Benefits

• Owners have limited liability for the company’s business debts.
• LLCs are straightforward to establish.
• LLCs can be run by members or managers.
• Many business expenses are tax-deductible.
• Pass-through taxation prevents double taxation.

How to Pay Yourself With an LLC

With an LLC, you enjoy the flexibility to decide how you’re paid out. Your options are taxable as self-employed income on your personal tax return. They include:

• Paying yourself with distributions from the business as personal assets
• Paying yourself with an owner’s draw (without having to file a W-2 or W-4)
• Paying yourself a steady salary (and filing the necessary W-2 tax form)
• Paying yourself a guaranteed payment if you’re not a full-time employee of the LLC
• Paying yourself dividends

S Corp

A small business can qualify as an S corporation if it has 100 or fewer shareholders. They must be individuals, specific trusts and estates, or specific tax-exempt organizations. International businesses, financial institutions like insurance companies, partnerships, and corporations are ineligible.

Tax Treatment

An S corp designation allows for pass-through taxes, so profits, losses, deductions, and credits are passed to individual shareholders who file them on their personal taxes. This avoids a higher corporate tax rate; instead, taxes are paid using the individual’s income tax rate.

Benefits

Although you lose the flexibility of structuring and managing your business, there are tax benefits to setting up the company as an S corp. These include:

• Corporate tax savings: Instead of paying higher corporate taxes, the S corp is taxed at the individual’s income tax rate.
• Personal income tax savings: Business expenses can be tax-deductible, reducing your taxable income.
• Corporate dividends: Shareholders can receive distributions that are tax-free if they don’t exceed their stock basis.

How to Pay Yourself With an S-Corp

There are clear expectations about how you pay yourself with an S corp. You’ll be paid via distributions and a “reasonable” salary. Here are the steps you’ll typically take:

Which One Should You Choose?

There’s no single best answer for which type of business entity you should choose since it completely depends on your business’s unique needs and plan for growth.

Flexibility

An LLC offers more flexibility when it comes to establishing the business structure and setting up management. An S corp requires directors and officers to oversee the running of the business, and S corps also have to adopt bylaws, issue shares, take minutes at shareholder meetings, and more. On the other hand, LLCs have fewer documentation requirements.

Taxation

Although the tax you’ll pay depends on your business, the S corp allows owners to avoid paying self-employment tax on their individual returns. Instead, the company will pick up the employer’s share of Social Security and Medicare taxes. Shareholder pass-through income is taxed as income, not self-employment income.

Complexity

Using an S corp is typically more complex because this structure has more stringent requirements. The IRS only allows small businesses with 100 or fewer employees to form S corps because they’re not subject to the corporate tax rate.

The Bottom Line

Both an LLC and an S corp are pass-through tax entities, so you’ll pay personal taxes on the income at the end of the year. Ultimately, the best business structure for you depends on your business needs and goals. Although LLCs offer more flexibility when it comes to establishing and managing the business, S corps have the advantage of giving the owners a salary and corporate distributions as a shareholder. If you’re still unsure about your best option, consult a reputable financial advisor.