Am I an Owner or an Employee of My Business?
As a business owner, you may be paid a salary, or you might take a draw as an owner. How you receive money from the business depends on the type of business you own. In this article, we'll look at the typical types of business entities and explain how the owner's status - and payment from the business - is determined.
Who decides if I'm an owner or employee?
Basically, tax laws are the deciding factor. The federal government (theInternal Revenue Service) has regulations that spell out how business owners are taxed, based on the type of business.
The tax status of the owner and how the owner gets paid should be a major factor in your decision to form a specific type of business. Before you decide on your business type, talk to your tax professional to be sure you understand the tax effects of your business ownership.
What is my status in the business?
Your status is either as an owner or as an employee, depending on the type of business:
- Sole proprietorship - you are the owner, not an employee.
- Limited liability company - you are most likely an owner (member), not an employee, unless you elect to be taxed as a corporation (see below).
- Partnership - you are an owner, not an employee.
- Corporation - you are an employee if you actively work in a position in the corporation. You are also a shareholder and you are also on the board of directors, so you have multiple roles.
- S corporation - you are an employee if you actively work in a position in the s corporation, and you are also a shareholder. Read more about self-employment and payroll taxes for S corporation owners.
How do I take money from my business? What's the tax effect?
If you are in business, you expect it will provide you an income (at some point, anyway). So how do you get money from your business? It depends on the type of business:
If You Own Stock in a Corporation
If you are the owner of a corporation, you own shares in that corporation. If you do work for the corporation (and not just sit back and collect dividends), you get paid for that work as an employee. The IRS says you must be paid a reasonable salary for that work; you can't just work for $1 a year to avoid the payroll taxes (Social Security/Medicare, unemployment).
All your employee wages must have FICA taxes (Social Security/Medicare) deducted, and the corporation must pay the other part of the FICA taxes, along with unemployment tax and workers compensation. You also receive dividends on your shares, for which you must pay taxes on your personal tax return (as investment income).
If You Own an LLC
Owners of LLCs are called Members. They do not receive a paycheck as an employee. Members receive money from the LLC in two ways:
- Return on Investment. They can take out money they have invested. This return on investment is not subject to employment taxes.
- Guaranteed Payments. LLC Members may also take out money from the business in the form of guaranteed payments.
If You Are a Sole Proprietor
If you are an owner of a sole proprietor business, you can take a draw from the business for personal expenses. This draw is not a deductible business expense; it's just money you take from profits (assuming there are profits!) to pay personal bills. When you take a draw, you should write a check to yourself from the business checking account and deposit it in your personal checking account.
It's important for business owners to keep business and personal expenses separate. Here's how that works for a draw: You decide you need money to pay personal expenses. You write a check from your business account, made out to you personally (as in "Ginny Doe"). Then you deposit the check into your personal bank account. The accounting entry is to debit your owner's equity account and credit cash.
If you are an Employee in a Corporation
If you are an employee, you take a salary from the business. Your salary must be reasonable, and it is considered a deductible business expense. If you are working in your corporation, you are considered an employee. You can't work for nothing and you can't get paid too much.
The corporation must give you a paycheck, just like other employees. The paycheck must including withholding of income taxes and FICA taxes (Social Security and Medicare). The corporation must also pay unemployment taxes and worker's compensation taxes on your earnings as an employee.
Corporate officers who are shareholders may also receive dividends as designated from the profits of the business.