Congratulations! Your business has started generating a profit and you have finally reached the point to reap the rewards of your hard work. There are two options to pay yourself (1) receive a salary through payroll or (2) distribute profits as an owner draw. The appropriate option will depend on your type of business.
Sole Proprietors, Partners, and LLCs
Sole Proprietors and Partners are able to pay themselves a distribution of profits at any time as an owner draw. Payroll withholding do not apply, but each individual essential pays the equivalent on his or her business income at tax time.
These types of individuals should consider paying themselves on a regular schedule to help establish a clear picture of how much the business costs to run and consider the eventual tax bill. You can implement a system for paying estimated taxes by writing monthly checks to the IRS or making estimated quarterly tax payments.
If your company is legally structured as an S Corporation, you must receive regular paychecks that include withholding for Social Security, Medicare, federal and state income taxes. You also have the option of taking additional money beyond your salary in the form of a draw or distribution. Checks for draws and distributions are written without withholding the taxes that are taken out of a regular payroll check.
The IRS requires you to earn reasonable compensation for your type of work. As a guideline, the government suggests choosing an amount similar to what another business would pay someone to do what you do. The IRS has scrutinized many S Corporations for choosing draws over payroll to avoid payment of payroll taxes. An S Corporation that takes this approach risks penalties and interest for incorrect payroll tax reporting.
Corporate Officers must be on payroll and receive regular checks that include withholding for Social Security, Medicare, federal income taxes, and state income taxes in states that require them.