How to Payroll Yourself as a Business Owner

Paying yourself as a business owner through payroll is a structured approach to compensation that brings clarity to your personal and business finances. This method distinguishes your owner’s income from the business’s overall profits, which is particularly beneficial for certain business structures. It involves treating yourself as an employee, complete with regular wage payments and tax withholdings. Understanding this process can help ensure compliance with tax regulations and provide a consistent income stream.

Choosing Your Business Structure for Payroll

For sole proprietorships and single-member Limited Liability Companies (LLCs) not taxed as corporations, owners typically compensate themselves through “owner’s draws.” These withdrawals of business profits are not subject to payroll taxes, as business income and expenses flow directly to the owner’s personal tax return.

In contrast, if your business is structured as an S Corporation, paying yourself a “reasonable salary” through payroll is a requirement set by the Internal Revenue Service (IRS). This mandate ensures that owner-employees contribute their share of payroll taxes, such as Social Security and Medicare taxes, on their compensation. The remaining profits can then be taken as distributions, which are not subject to these payroll taxes. This distinction is a primary reason many business owners elect S Corporation status, balancing salary and distributions for tax efficiency.

For partnerships and multi-member LLCs, owners typically receive “guaranteed payments” or draws from business profits. Payroll is generally not used to compensate owners, as their share of business income is subject to self-employment taxes. However, if these entities hire employees, including an owner working in a capacity separate from their ownership duties, payroll for those specific employee roles is necessary.

Gathering Required Identifiers and Information

Before establishing a payroll system, a business owner needs to secure essential identifiers and compile specific information. A federal Employer Identification Number (EIN), a unique nine-digit tax ID issued by the IRS, is mandatory for any business that hires employees or operates as a corporation or partnership. An EIN can be obtained for free directly from the IRS, with online applications often providing the number immediately.

Beyond the federal EIN, most states require businesses to register for separate state tax identification numbers. These state IDs are necessary for remitting state income tax withholding, unemployment insurance contributions, and other state payroll taxes. The registration process and required information vary by state, often involving applications with the state’s Department of Revenue or Department of Labor. Complete these state registrations before processing payroll to ensure compliance.

Compiling personal information for the owner-employee, such as full legal name, current address, and Social Security Number, is necessary for payroll setup. If direct deposit is desired, bank account details, including routing and account numbers, are needed. Maintaining a separate business bank account is crucial for clear financial record-keeping and to facilitate payroll transactions.

Calculating Your Payroll and Withholding Taxes

Calculating payroll involves determining gross pay and then subtracting various withholdings to arrive at net pay. For S Corporation owners, determining a “reasonable salary” is a first step. The IRS defines a reasonable salary as what a comparable business would pay an employee for similar job duties, considering factors like experience, qualifications, time devoted to the business, and industry standards. This reasonable salary is subject to all applicable payroll taxes.

Federal withholding taxes include federal income tax, calculated based on information provided on an employee’s Form W-4. Federal Insurance Contributions Act (FICA) taxes, comprising Social Security and Medicare taxes, are also withheld. The Social Security tax rate is 6.2% for both the employee and employer, applied to wages up to an annual limit. The Medicare tax rate is 1.45% for both employee and employer, applied to all wages without a limit. An additional Medicare tax of 0.9% applies to an employee’s wages exceeding a certain threshold, withheld only from the employee’s portion.

State and local withholding taxes also factor into payroll calculations and vary by jurisdiction. These may include state income tax, local income tax, state unemployment insurance (SUTA), and state disability insurance. The employer is responsible for withholding the employee’s portion of these taxes and contributing the employer’s share.

Processing Your Payroll and Remitting Taxes

Processing payroll involves steps to ensure accurate payment and tax compliance. Many business owners use dedicated payroll software or a professional payroll service provider. These systems automate calculations, manage withholdings, and ensure timely tax remittances, reducing administrative burden and risk of errors. Once a system is chosen, gathered identifiers and personal information are entered to set up employee profiles.

When running payroll, the gross salary is entered, and the system calculates all federal, state, and local taxes to be withheld. After reviewing calculations for accuracy, the payroll run is approved. Funds are disbursed to the owner-employee, typically through direct deposit, a common and efficient method for wage payment.

Remitting payroll taxes to the appropriate government agencies is a key step. Federal taxes, including withheld income tax and FICA taxes, are generally paid through the Electronic Federal Tax Payment System (EFTPS). The frequency of federal tax deposits depends on the business’s total tax liability, usually monthly or semi-weekly. State and local payroll taxes are remitted to their respective agencies according to their specific schedules and methods, which vary by state.

Annual Reporting Requirements

At the close of each calendar year, businesses with employees, including owner-employees, must fulfill annual reporting obligations. A primary requirement is issuing Form W-2, Wage and Tax Statement, to each employee by January 31st of the following year. This form reports total wages paid and taxes withheld throughout the year, enabling the employee to file their personal income tax return.

Along with individual W-2s, employers must file Form W-3, Transmittal of Wage and Tax Statements, with the Social Security Administration (SSA) by January 31st. Form W-3 serves as a summary of all W-2 forms submitted, providing cumulative totals of wages and withheld taxes for all employees. This transmittal form helps the SSA verify that reported wages and FICA taxes align.

The Federal Unemployment Tax Act (FUTA) also requires an annual return, Form 940, Employer’s Annual Federal Unemployment Tax Return. This form reports the federal unemployment tax liability for the year, which is solely an employer-paid tax. States often have their own annual reconciliation forms for state income tax withholding and unemployment insurance, which summarize the year’s state payroll tax activity.

For S Corporation owners, payroll income reported on Form W-2 integrates with their personal tax return. Any remaining business profits distributed to the owner are reported on Schedule K-1 (Form 1120-S). This form details the owner’s share of the corporation’s income, which is generally not subject to self-employment taxes, provided a reasonable salary was paid through payroll.