How to Pay Yourself From Your Business Without Triggering IRS Red Flags

As a business owner, paying yourself isn't as simple as transferring money from your business bank account to your personal one—at least not if you want to stay on the IRS's good side. The method you use depends on your business structure, and getting it wrong could result in tax penalties or an audit.

Here's how to pay yourself the right way—while keeping the IRS off your back.

1. Know Your Business Structure

The IRS looks at different business types in different ways. Your pay strategy should align with your legal structure:

Sole Proprietors & Single-Member LLCs:

You don't get a "paycheck" in the traditional sense. You take an owner's draw—transferring profits to your personal account. These draws aren't taxed when taken, but you'll owe income and self-employment tax when you file your return.

Example: Sarah runs a photography business as a sole proprietor. She transfers $3,000 from her business to her personal account each month. This is considered an owner's draw, not a salary.

S Corps & C Corps:

You must pay yourself a reasonable salary through payroll, subject to payroll taxes. Additional profits can be taken as distributions (S Corp) or dividends (C Corp), which may be taxed at a lower rate.

Example: John owns an S Corp marketing agency. He pays himself a $70,000 salary (reasonable for his role) and takes an additional $30,000 in profit distributions—avoiding self-employment tax on the distributions.

Partnerships:

Partners generally can't be treated as employees. They take guaranteed payments or profit distributions. Guaranteed payments are subject to self-employment tax.

Example: Lisa and Kevin are 50/50 partners in a consulting firm. They each receive monthly guaranteed payments of $5,000, plus year-end profit splits based on performance.

2. Avoid Common IRS Red Flags

Unreasonable Salaries:

S Corp owners paying themselves too little to avoid payroll taxes is a top audit trigger. The IRS expects salaries to reflect market rates for the work performed.

Commingling Funds:

Avoid using business accounts for personal expenses. This not only weakens liability protection but also attracts IRS scrutiny.

Inconsistent or No Payments:

Sporadic or missing compensation, especially in corporations, can appear suspicious. Document regular payments and how they were determined.

3. Best Practices

• Use Payroll Services: Tools like Gusto or ADP ensure proper tax withholdings and compliance.
• Keep Books Clean: Separate personal and business finances.
• Consult a CPA: A tax professional can help determine a reasonable salary and structure your compensation strategy for tax efficiency.

Need Help Structuring Your Payroll?

If you'd like professional guidance on how to pay yourself the right way, schedule a 15-minute free consultation call with our experienced CPAs. We'll help you structure your personal payroll for tax savings and peace of mind.