How do I pay myself?
December 30, 2024
by a searcher from Columbia University - Columbia Business School in Washington, DC, USA
After buying a biz, do you put yourself on the payroll as a W2 or just take distributions? Is there a difference in W2 vs K1 income? Ie is w2 “more expensive” once fully burdened?
from Harvard University in Lynbrook, NY 11563, USA
It all depends on your tax structure. If you're entity is a partnership (including an LLC taxed as a partnership), then you CANNOT BE A W2 period as you can't be an employee of your own partnership. All your earnings are reported to you on a K-1, and unless you legitimately interpose a holding entity between you and the partnership, will be subject to self-employment tax (FICA/social security etc.).
If your entity is an S corp (including an LLC taxed as an S corp), then you'll need to pay yourself a "reasonable salary" as a W2, which you can take more conservative or aggressive positions on as long as you're comfortable that you can back it up if you're ever audited. The rest of your share of the Company's income will come out to you on a K-1 (S-Corps have K-1s too) and is not subject to self-employment tax. There can be substantial tax savings to you in this structure (10-30k+ a year potentially), but if you're taking on investors, this would be the tail wagging the dog.
Even if you're entity is a partnership, you may be able to hold your interest in the partnership through an S corp that you own individually, and take advantage of the S corp benefits described above, but there's some question about that. Talk to your advisor.
from University of Virginia in Simi Valley, CA, USA
The IRS is looking for business owners who underpay themselves W-2 wages, thus trying to minimize social benefit taxes. The IRS doesn’t like when business owners do this. So, as an owner and operator, you must pay yourself “reasonable” wages. Think about it this way: What would be a reasonable market compensation rate if you had to hire someone to do what you do?
You may have some restrictions on payments – loan covenants, sellers' notes, imposed restrictions, etc., so these can justify lower wages. Be sure you have a well-documented and articulated justification of your W-2 wages.
You may also want to consider various benefit packages, such as deferred executive compensation, 401(k) company match, and good healthcare benefits, including HSA with company match. However, these must be done correctly to avoid discriminatory treatment of other employees, as all employees of the same category/class should have an equal compensation structure.
Be aware that some benefits, e.g., corporate car, can be interpreted by the IRS as fringe benefits that should be included in your payroll for income tax calculation.
You should consult with your tax advisor.