Compensation depends on the type of business you run.
- Sole Proprietorship or Partnership: In most cases, you’re not allowed to be on payroll. You can still pay yourself from the business’ income, but that pay is not tax-deductible unless you’ve received some kind of special exemption. Partnership agreements allow for pay to be given in various ways, but it’s usually best to take distributions and make estimated tax payments. It’s best to have payments made on a regular basis, rather than drawing out pay whenever you feel like you need (or want) it.
- Corporations: Officers are W-2 wage earners.
- S Corporations: S Corps are similar to C-Corps, but you can also pay yourself through tax-free distributions. Don’t start celebrating – you still need to take an amount in payroll that the IRS will call “reasonable”, which usually means compensation similar to what similar people in similar positions receive. Payroll will be a tax-deductible business expense, but your distributions won’t be.
- Limited Liability Companies: These companies are regulated based on state laws, not federal laws. If you have an LLC, the IRS defaults your tax status to either sole proprietorship (if you’re the only owner) or partnership (if there are multiple owners). Alternatively, you can elect S Corporation status with the IRS for tax purposes. As noted above, this tends to be more favorable tax-wise than the distribution-only method that sole proprietorships and partnerships have to deal with.