TAX TIPS (and other stuff)
By Kelly J. Bullis, CPA
2025-July 19th
You own a business. How do you pay yourself? Well, that depends. Whether you are looking to maximize your qualified business income (QBI) deduction or take advantage of employee fringe benefits, incorrectly paying yourself wages can cause serious issues.
First, you need to understand that there are two different taxes that business owners need to be aware of. The first is obviously income tax. The second is called “self-employment” which is basically Social Security and Medicare for small business owners. That second tax totals 15.3% of the taxable income. But there are all kinds of ways for a small business to report its operations for income tax purposes. That determines the self-employment taxation process.
Sole-Proprietors are businesses (which could be non-LLCs or single-member LLCs) that are not a Partnership, Sub-S Corporation or Corporation. Owners are not allowed to pay themselves a w-2 salary. Instead, all the taxable income generated from the business is reported on their personal income tax return and is subject to both income tax and the self-employment tax.
Partnerships (which can be multi-member LLCs or a legal partnership) are also not allowed to pay themselves a w-2 salary. Instead, partners are compensated by “guaranteed payments” (which are reported on the Schedule K-1) and the remaining profits (distributed or not) are also reported on the partner’s personal income tax return, via that same Schedule K-1. Guaranteed payments are always subject to self-employment tax. Profits, only for “general” partners, are subject to self-employment tax. Limited partners’ profits are NOT subject to self-employment tax.
Sub-S Corporations (which can be an LLC or a regular corporation) are my favorite default option for a business that is profitable enough. The profits from a Sub-S are NOT subject to self-employment tax. They are reported on the owner’s personal income tax return via a schedule K-1. BUT the IRS expects you to pay yourself a w-2 “reasonable salary” (which does have to report Social Security and Medicare withholdings, and the business pays the employer portions). The BIG question, is “What is a reasonable salary?” The IRS likes to say, “What would you pay somebody to do the job you do?” To maximize your QBI, you want your salary to be smaller, not larger. You ever heard the old saying, “Pigs get fat, hogs get slaughtered, so don’t be a hog!” Trying to come up with a “reasonable salary” is kind of like the pig vs hog analogy. In fact, next week’s subject will be all about this topic.
Finally, there is the old tried and true Corporation option. This is the best option if you want to take advantage of a lot of employee benefits. There is no QBI for this option. Corporations pay a flat tax at 21%. So go ahead of pay yourself as large a w-2 salary as you want in order to take out the profits from the company. The only other way to take profits out is by paying yourself dividends. The problem is, dividends are taken out after the Corporation has paid its tax on those profits, then you pay tax again on the dividends you take out. The classic “double taxation” trap of regular corporations.
Have you heard? 1 Samuel 12:21 says, “Don’t turn away to go after vain things which can’t profit or deliver, for they are vain.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. On the web at BullisAndCo.com Also on Facebook.
