Sole proprietors, partners in a partnership, and members of an LLC don't receive a traditional paycheck from the business. Instead, any money they withdraw from the business bank account for non-business expenses is considered a draw.
Draws aren't deductible business expenses. Instead, they reduce the owner's share of equity in the business.
In these types of businesses, the business owner pays taxes on all business profits on their individual income tax return, whether they withdraw money from the company or not. In other words, draws are subject to income taxes, as are any profits that remain in the business banking account.
Partners in a partnership and members of a multi-member LLC (meaning more than one owner) can also receive guaranteed payments for the work they do in the business. This is in addition to any draws they take from the business.
Guaranteed payments aren't based on the entity owner's share of ownership. Instead, they are more like a salary to compensate a partner or member who manages the day-to-day operations of the business on a full-time basis. However, unlike a salary, the business doesn't withhold income or payroll taxes - the partner or member must report the guaranteed payment on their individual tax return and pay all state, federal, and payroll taxes, including self-employment taxes, on it. Unlike draws, guaranteed payments are a deductible business expense for the company.
Owners/officers of S corporations and C corporations (or members of LLCs that have elected to be taxed as a corporation) who work for the business are considered employees of the corporation and receive a regular paycheck with income and payroll taxes withheld. The key is determining reasonable compensation.1 S corporation owners have an incentive to pay themselves a low salary to reduce the amount of self-employment tax they pay, while C corporation owners have an incentive to pay themselves high salaries to avoid double taxation2 on corporate profits.
In addition to their salary, S corporation owners can take additional compensation from the company in the form of distributions, also known as non-dividend distributions. These are different from the dividends that C corporation shareholders receive because the S corporation owner doesn't receive Form 1099-DIV or have to pay taxes on the distribution.
Owners of an S corporation are already taxed on their share of the company's profits, whether they take the money out of the company or leave it in to be reinvested. As a result, these distributions are tax-free, as long as the distributions aren't greater than the shareholder's basis.3 Like partnerships and LLCs, an S corporation owner's basis is essentially their original equity contribution to the business, plus all cumulative profits, less any distributions they've received from the company.
In addition to their salary, owners of a C corporation can receive dividends from the company. This is where the double taxation comes in, since dividends are taxable income to the recipient, even though the corporation has already paid taxes on the income. Recipients of the dividends are usually taxed at the long-term capital gains tax rate of 20%.4
Whichever form of business you choose, deciding how much to pay yourself comes down to striking a balance between how much money you need to take out of the business to live, and how much to keep in so your business can operate and grow.
If you need help, call or visit your nearest Synovus Branch to learn more about moving funds from business to personal checking and other services that can help you manage your company's finances.