As a business owner, figuring out how to pay yourself can be challenging. Should you take a salary, dividends, or a combination of both? The right strategy depends on your business structure, tax obligations, and income needs. Understanding your options can help you optimize your earnings while staying tax-compliant.
Key Methods for Business Owner Compensation
Different business structures have different rules for 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.
- 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.
📞 Contact us today to see how we can support you in developing the right compensation plan for your business.