Guaranteed Payments vs. Salary: Key Differences for Owners
Understand how your business entity dictates owner compensation. This guide clarifies the distinct tax and compliance rules for paying yourself correctly.
A business owner’s compensation method is determined by the company’s legal and tax structure. The two primary methods for paying owners for their direct contributions are guaranteed payments and salaries. While both compensate an owner for labor, they are distinct concepts with different tax rules and reporting requirements.
Understanding Guaranteed Payments
A guaranteed payment is compensation made by a partnership to a partner for services or the use of capital. A defining characteristic is that the payment is made regardless of the partnership’s income, meaning the partner is paid even if the business has a loss. This method is exclusive to partners in a partnership and members of an LLC taxed as a partnership.
Guaranteed payments are treated as self-employment income for the receiving partner and are subject to self-employment tax. The self-employment tax rate is 15.3%. This rate consists of a 12.4% Social Security tax on earnings up to the annual limit ($176,100 for 2025) and a 2.9% Medicare tax on all earnings. An additional 0.9% Medicare Tax also applies to earnings exceeding certain thresholds, such as $200,000 for single filers or $250,000 for married couples filing jointly.
The receiving partner is responsible for paying these taxes and must make quarterly estimated tax payments to the IRS. For the partnership, guaranteed payments are treated as a deductible business expense. This deduction reduces the partnership’s ordinary business income, which lowers the total taxable income passed through to all partners.
The partnership reports these payments on its annual tax filing, Form 1065. The details are then communicated to the receiving partner on Schedule K-1. The partner uses this information to report the income on their personal tax return on Schedule E and to calculate their self-employment tax on Schedule SE.
Understanding Salary
A salary is fixed compensation paid to an individual for services as an employee. This structure is used for owner-employees of S corporations and C corporations. When an owner is paid a salary, they are an employee of the corporation, and their compensation is processed through the company’s payroll system.
A salaried owner-employee is subject to payroll tax withholdings. The corporation withholds federal and state income taxes, as well as the employee’s share of FICA taxes for Social Security and Medicare. The employee’s share of FICA tax is 7.65% of their gross wages, which consists of a 6.2% Social Security tax and a 1.45% Medicare tax.
The salary paid to an owner-employee is a deductible business expense for the corporation. The corporation must also pay the employer’s matching share of FICA taxes, which is an additional 7.65% of the employee’s salary. This employer tax payment is also a deductible business expense.
Salary reporting is managed through payroll. The corporation must provide each owner-employee with a Form W-2 by January 31 of the following year. The corporation is also responsible for remitting withheld taxes and its share of payroll taxes to the IRS by filing Form 941.
Application by Business Entity
The choice between a guaranteed payment and a salary is dictated by the business’s legal structure. For partnerships and LLCs taxed as partnerships, owners providing services cannot be W-2 employees. Their compensation for labor must be structured as a guaranteed payment or a distributive share of profits, as these entities are prohibited from paying salaries to partners.
Conversely, S corporations have different rules. An owner of an S corporation who provides services to the business is required to be paid a reasonable salary. The owner must be on the company payroll and receive a W-2 with associated payroll taxes withheld. The IRS requires the salary to be reasonable for the services performed to prevent owners from avoiding payroll taxes by taking only distributions.
Reasonable compensation is based on what a similar business would pay for comparable services, considering factors like the owner’s duties, experience, and time commitment. The IRS scrutinizes S corporation compensation to ensure compliance. Paying an unreasonably low salary while taking large distributions can be viewed as a strategy to evade payroll taxes.
Salaries and guaranteed payments must be distinguished from profit distributions. A distribution is a payment to an owner from company profits, representing a return on equity investment, not compensation for services. For an S corporation owner, distributions are reported on Schedule K-1 and are not subject to FICA taxes. For a partner, distributions are not subject to self-employment tax, though their share of the partnership’s overall income is.