Is an Owner's Salary Tax Deductible?
- According to the IRS, "self-employed" generally refers to sole proprietors or partners in a company. The company's profit and loss flows through to the individual tax returns. This means you do not deduct your income from your tax return. Instead, all of this money is reported on your tax return under schedule C of your 1040.
- The IRS requires that when you're incorporated, you must report your corporate income on a corporate tax return. But you may also draw a salary from the corporation. This counts as a deduction for the business but a taxable event for you. All profits of an S corporation flow through to you, so the owner's salary is not deductible to the S corporation. However, you may pay out a portion of the profits as a dividend, thus saving you some money on your personal tax return since these dividends aren't subject to Medicare and Social Security tax. An LLC may be taxed like a corporation, partnership or sole proprietor and must file accordingly.
- Getting a tax deduction for salary paid to you does not absolve you of paying your tax debt. You must still pay taxes. The only question is how those taxes will be paid. Either the corporation will pay them or you'll pay them.
- If you're a sole proprietor or part of a partnership, consider incorporating. Incorporation offers you more than just tax benefits. You get the benefit of legal limited liability if you're sued. Only the assets of the business are subject to a claim made by creditors when you're incorporated. A C corporation is the only corporate entity that the IRS recognizes as not being a "pass through" entity, for which income passes through to the owner directly. Because of this, if you want the ability to deduct salary from taxes, your only real option is to form a C corporation.