J.K. Lasser's Small Business Taxes 2013: Your Complete Guide to a Better Bottom Line

Compensation to Owners

How much should you pay yourself? What are the tax ramifications? The answers depend on your business’s financial situation, your personal needs, how the business is organized, and more.

Employee versus Self-Employed

If your business is a corporation, whether C or S, you are an employee if you provide services for the corporation. Compensation is deductible by the corporation and taxable to you. Compensation is subject to Social Security and Medicare (FICA) taxes.

In contrast, if you are a self-employed person because your business is a sole proprietorship, partnership, or limited liability company, you do not receive compensation. Instead, you can take a draw, which can be fixed to appear like a salary. The draw is not deductible by the company; it is not separately taxable to you (it is part of the net earnings from the business on which you are taxed). The draw is not separately subject to self-employment tax (which is effectively the employer and employee share of Social Security and Medicare taxes). Instead, self-employment tax is paid on all of the net earnings allocated to the owner (with some modifications), regardless of whether earnings are paid out (as draw or otherwise) or retained by the business.

Guaranteed payments to partners are different from a draw. These payments are made for services without regard to the income of the partnership. The payments are deductible by the partnership (before determining partnership profit or loss), are treated ...