Business Owner Pay Themselves a W-2 Salary? 4 points to consider.

Understanding Schedule C Business Owners and Payment Options

A Schedule C business is typically a sole proprietorship (same as Single-Member LLC) where you report your business income and expenses on Schedule C of your personal tax return (Form 1040). As the business owner, you have two main options for paying yourself: taking an owner's draw or paying yourself a W-2 salary.

4 Key Questions About Schedule C Business Owners and W-2 Salaries

1. Is paying yourself a W-2 salary appropriate when filing taxes as a Schedule C business owner?

For a Schedule C business owner (sole proprietor), paying yourself a W-2 salary is generally not appropriate or allowed by the IRS. As a sole proprietor, you and your business are considered the same legal entity. The IRS does not recognize you as both an employer and employee of the same business.

Instead, sole proprietors must use the owner's draw method to pay themselves. The business profits reported on Schedule C are considered your personal income, and you pay taxes on those profits regardless of how much money you actually withdraw from the business.

2. Will a business owner save on taxes by setting up a payroll account and issuing a W-2 salary?

A Schedule C business owner cannot save on taxes by paying themselves a W-2 salary because it's not allowed in this business structure. However, if you were to change your business structure to an S Corporation, you could potentially save on self-employment taxes.

With an S Corporation, you can pay yourself a reasonable salary (subject to payroll taxes) and take additional money as distributions, which aren't subject to self-employment taxes. This structure requires filing different tax forms and following different rules than a Schedule C business.

3. What's the impact on self-employment taxes for Schedule C business owners?

As a Schedule C business owner, you must pay self-employment taxes (15.3%) on your net business income. This covers both the employer and employee portions of Social Security and Medicare taxes.

You cannot reduce these taxes by paying yourself a W-2 salary within a Schedule C business. However, you can deduct the employer portion (7.65%) of self-employment taxes on your personal tax return, which provides some tax relief.

If you're concerned about high self-employment taxes, consulting with a tax professional about potentially changing your business structure might be worthwhile. Commonly, converting from a Single-Member LLC Schedule C filer to an S-Corp, saves the most tax.

For more information on how to convert from a Single-Member LLC Schedule C filer to an S-Corp:

4. Is there a concern regarding double taxation for Schedule C business owners?

Double taxation is not a concern for Schedule C business owners. Your business income passes directly to your personal tax return and is taxed only once at your personal income tax rates.

Double taxation typically refers to C Corporations, where profits are taxed at the corporate level and then taxed again when distributed to shareholders as dividends. This is not the case for Schedule C businesses or other pass-through entities like S Corporations and LLCs.

Example Scenarios:

Scenario 1: Sole Proprietor Earning $80,000 Profit

Marcus runs a consulting business as a sole proprietor, reporting $80,000 in net profit on Schedule C after expenses.

• He cannot pay himself a W-2 salary

• He takes owner's draws of $5,000 monthly for personal expenses

• He pays self-employment tax of $12,240 (15.3% of $80,000)

• He can deduct half of his self-employment tax ($6,120) on his tax return

• His tax liability is based on the full $80,000 profit, not just the $60,000 he withdrew

Scenario 2: Business Owner with $150,000 Profit

Michael's business generates $150,000 in net profit. He's considering whether to remain a Schedule C business or switch to an S Corporation.

As a Schedule C Business:

• Pays self-employment tax on full $150,000 ($22,950)

• Cannot pay himself a W-2 salary

• All profits flow to his 1040 personal tax return

If Converted to S Corporation:

• Could pay himself a reasonable salary of $80,000 (subject to payroll taxes)

• Must set-up payroll account and pay regular remittances to IRS/state

• Could take remaining $70,000 as distributions (not subject to self-employment tax)

• Potential tax savings: approximately $3,000-$8,000

Business Structure Options for Schedule C Owners

If you're currently operating as a Schedule C business owner and want the ability to pay yourself a W-2 salary, you'll need to change your business structure. Here are the main options:

To learn more strategies for reducing your tax burden and maximizing your take-home pay, check out Taxation Intel

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