As a business owner, figuring out how to pay yourself is an essential part of managing your finances — and it all comes down to choosing the right owner compensation strategy. Should you take a salary, dividends, or a combination of both?
The best approach depends on your business structure, tax obligations, and income needs.
In this article, we’ll break down the most common methods of owner compensation and help you decide which strategy is right for your business. Understanding your options can help you optimize your earnings, stay compliant, and protect your bottom line.
Key Methods for Business Owner Compensation
Different business structures have different rules for owner compensation. Understanding the nuances between various business structures, such as S-Corp vs. LLC tax strategies, is crucial for determining optimal owner compensation.
Here are the three most common methods and when to use them.
1. Salary – Best for S-Corps and C-Corps
If your business is structured as an S-Corp or C-Corp, taking a reasonable salary is typically required. Here’s what you need to know:
- Treated as Employee Wages – Salaries are taxed as ordinary income and subject to Social Security and Medicare (FICA) taxes.
- Compliance Matters – The IRS requires S-Corp owners who actively work in their business to take a reasonable salary before distributions. Learn more about the IRS’s reasonable compensation guidelines here. Adhering to startup tax essentials ensures compliance when processing salaries through payroll.
- Payroll Considerations – Salaries must be processed through payroll, meaning you’ll have withholding obligations and payroll taxes.
2. Dividends or Distributions – Best for LLCs and S-Corps
For LLCs and S-Corps, owner compensation can also come from dividends or profit distributions. Here’s how it works:
- Lower Tax Rates – Distributions are generally not subject to payroll taxes, making them a tax-efficient way to withdraw profits.
- S-Corp Owners Must Take a Salary First – To prevent tax avoidance, the IRS requires S-Corp owners to take a reasonable salary before taking distributions.
- LLC Flexibility – LLC owners can take distributions based on business profits, but they may be subject to self-employment tax. Learn more about self-employment tax from the IRS.
3. Combining Salary and Dividends for Tax Efficiency
Many business owners blend salary and distributions to maximize tax efficiency. Here’s why this approach works:
- Reduces Payroll Taxes – Taking a modest salary and supplementing it with distributions can lower payroll tax burdens. The IRS provides a breakdown of dividend taxation here.
- Ensures a Steady Income Flow – A salary provides predictable earnings, while distributions offer flexibility.
- Requires Strategic Planning – A tax professional can help balance salary vs. dividends to stay compliant and minimize taxes.
Choosing the Right Owner Compensation Strategy for Your Business
Deciding how to pay yourself depends on:
- Your Business Structure – LLC, S-Corp, or C-Corp? Each has different tax implications. Check out the SBA’s guide on choosing a business structure for deeper understanding.
- Your Income Needs – Do you need consistent cash flow, or can you afford flexibility?
- Your Tax Strategy – Balancing payroll taxes, income taxes, and deductions is key.
If you’re unsure about the best approach, our team at Beckley & Associates is here to help. Let’s work together to ensure you’re paying yourself correctly and efficiently while optimizing your tax strategy.
At Beckley & Associates PLLC, a trusted advisory, tax and accounting CPA firm in Plano, TX, we specialize in helping individuals and small business owners.
Contact us today to discover how our local expertise can support your financial success.