Business owners have many options when it comes to structuring their entity and whether or not they pay themselves a salary or just draw from the company profits. Deciding the best option from a tax liability standpoint can often be confusing. Here are some basic guidelines on when a business owner should take payroll.

Sole Proprietorships/Partnerships: Many small businesses start out as a sole proprietor or in the case of two or more people involved, a partnership. For tax purposes, these entity structures do not offer any advantage or disadvantage for the company officers to take payroll. In a sole proprietorship, the owner can pay himself or herself any time there are profits from which to draw from. Partnerships work essentially the same way, except that the frequency and types of payments must be agreed upon by all parties involved. In either case, whatever profits the entity has go out to the owner(s) and are subject to both income and self-employment tax.

Limited Liability Corporations/Partnerships (LLC/LLPs): LLC’s fall into a special category as far as the federal government is concerned. Because they are governed by the individual state laws where the company is based, the IRS allows you to decide which entity structure to report for tax purposes. For example, in the case of a small business operated by a single owner, an LLC may be treated essentially the same as a sole proprietorship. The same holds true concerning the relationship between an LLP and a partnership.

Corporations: Corporation owners/officers are required to take payroll up to the amount that is considered reasonable for the services the owners provide. These payroll withholdings are subject to income and payroll tax just like any other employee. The advantage for the company is that these salaries can be deducted from overall profits (if any) and reduce the potential corporate income tax liability. This avoids the problem of “double taxation”. That is, taxing corporate income once as a profit and taxing the income again as a dividend to a shareholder. The advantage for the individual owner is having an income that can be verified from which to obtain credit for major purchases such as homes, cars, boats, etc.

Clearly, there is much more that goes into determining the implications of paying salary to company owners. For example, S corporations have their own set of rules for paying out company profits. The complicated federal, state, and local tax laws also add to the confusion. To ensure that you are in full compliance, as well as keeping your tax liability as low as possible, it is always best to seek the guidance of a qualified accounting professional.