Being a business owner means wearing lots of different hats, but is one of those hats “employee”? Not all business owners are classified as employees, but a select few are—and how you’re categorized affects your pay, tax obligations, and benefits. That’s why it’s crucial to understand when you’re a business owner versus when you’re a business owner and an employee. To figure it out, let’s dive into some specifics.
Am I a business owner and an employee?
Whether or not you’re a business owner and an employee depends on how your business is structured. The most common business structures include:
As a sole proprietor, you’re the sole owner of an unincorporated business. There’s no separation between you and your business, so you’re entitled to all business profits, but you’re also responsible for all the business’s debts and liabilities. As a sole proprietor, the business income is your pay, and you report it on your personal tax return. You also have to pay income tax, self-employment taxes, and estimated taxes.
The takeaway: As a sole proprietor, you’re considered a business owner, not an employee.
If you’re in a partnership, you own your business along with one or more partners. You can either have a limited partnership or a limited liability partnership.
A limited partnership means one partner has unlimited liability—meaning their personal assets are at risk if the company is in financial trouble—as well as management control. The other partner has limited liability, so their personal assets are protected from company losses. A limited liability partnership, on the other hand, gives limited liability to all the partners involved.
The takeaway: As a partner, you’re considered a business owner, not an employee.
Limited liability company
A single-member limited liability company (SMLLC) is an incorporated business that has the liability protection of a corporation—and the tax setup of a sole proprietorship. (From a tax perspective, it’s a disregarded entity.) If you’re the sole owner (also called a member) of the LLC, you take your personal income from the business income and pay taxes like you would in a sole proprietorship. All business proceeds (whether you take a draw or not) are reported on your personal income taxes.
However, if you’re one of multiple members, you pay taxes like you would in a partnership, which means you report your share of business income on your personal tax return.
The takeaway: As a member of an LLC, you’re considered a business owner, not an employee—unless you structure your LLC as a C corp or S corp. More on that below.
A C corporation, also called a corporation, offers business owners the highest liability protection because it’s a separate legal entity. If you own a corporation, your company will pay income taxes on its profits. However, your corporation can also get taxed again when shareholders receive their dividends; this is called double taxation.
If you own a corporation and also work there—as the CEO or CFO, for example—you’ll receive a W-2 for your wages earned and will have to pay income tax on your personal tax return. (This is seperate from and in addition to taxes you’ll pay on dividends you may receive as a shareholder.) As an employee, you’re entitled to employee benefits per your company benefits policies.
The takeaway: As the owner of a C corp, you’re considered a business owner. However, if you work for the company as a W-2 employee, you’re also considered an employee.
An S corporation is a type of corporation that has special tax rules. If you own an S corp, you may be able to pass your company’s profits through to your personal income without paying corporate tax rates. Keep in mind that you have to meet certain criteria to qualify as an S corp. You may also be subject to different tax rules depending on the state you file in.
Similar to a corporation, if you own an S corp and also work in the company, you’ll have to pay income taxes on your personal tax return. (This is seperate from and in addition to any taxes you pay on distributions you may receive as a shareholder.) As an employee, you’re entitled to employee benefits per your company benefits policies.
The takeaway: As the owner of an S corp, you’re considered a business owner. However, if you work for the company as a W-2 employee, you’re also considered an employee.
How can I pay myself?
Your business’s structure also influences how you pay yourself as a business owner. There are three main payment methods:
1. Owner’s draw
A draw is when a business owner takes money out of their business for personal income. Depending on your business’s cash flow, you can either take draws at weekly or monthly intervals, or simply pull money when you need it.
With a draw, you don’t pay separate taxes on the money you take out; you just pay taxes for all your business income on your personal tax return. Draws work well for sole proprietorships, partnerships, multi-member LLCs, and single-member LLCs.
A salary is a predetermined amount of money you give yourself during each pay period. When you pay yourself a salary, taxes are automatically taken out of your paychecks. Salaries work well for both C and S corporations.
A dividend is a distribution of company profits that goes to the shareholders of that company. Shareholders are people who own pieces of equity in a corporation. As the owner of a corporation, you can pay yourself a salary and take dividends. Dividends are typically taxed at a capital gains rate at the federal level (state tax policies vary) and are on your personal tax return.
A distribution is similar to a dividend, but it’s used in S corps. As with a dividend, shareholders of S corps can receive distributions from the company’s profits. A key difference, however, is that shareholders of S corps can generally take tax-free distributions to the extent that they have basis in the company.
As the owner of an S corp, you’ll pay capital gains tax on any distributions you receive in excess of your basis of the company (state taxes vary), but you will not pay self-employment tax on distributions. (Remember: you must also pay yourself a reasonable salary if you work in the company, which is subject to regular income tax.)
|Business structure||Method of payment||Tax forms|
|Sole proprietorship||Owner draw||Form 1040|
|Partnership||Owner draw based on partnership agreement||Form 1065|
|Single-member LLC||Owner draw||Form 1040|
|Multiple-member LLC||Owner draw based on membership agreement||Form 1065|
|C corporation||Salary, dividends||Form 1120|
|S corporation||Salary, distributions||Forms 1120S and 1040|
What benefits can I take advantage of?
Your classification as a business owner also affects which benefits you’re able to take advantage of.
If you’re a sole proprietor, partner, or LLC member and you don’t have any employees, you probably won’t qualify for a business group health insurance plan. Instead, you’d likely have to apply for individual health insurance.
However, if you do have employees, you may be eligible for a group insurance plan. To receive benefits as a corporation owner, though, you need to be an actual employee, not just a shareholder.
Every state has different laws when it comes to workers’ compensation insurance, but generally, if you have employees then you’re required to offer workers’ compensation to them. Whether or not you opt to cover yourself is a different story. Some states don’t require business owners to purchase workers’ compensation insurance coverage for themselves. You can check here to find out what your state’s rules are around workers’ compensation.
As a sole proprietor, partner, or LLC member, you can apply for a solo 401(k) plan, also called a self-employed 401(k) plan. As the owner of a C corp or S corp, you can only participate in your company’s 401(k) plan if you’re also a common-law employee.
Finding the right business structure for you
Your business’s structure dictates how you get paid, how you handle taxes, and which benefits you’re eligible for. If you’re creating a new business or if you’re considering changing your business’s structure, it’s a good idea to weigh the following factors before making a decision:
- Your business goals: What do you envision for your business in the short and long term? If you plan on hiring employees or seeking funding from investors at some point, you may want to file as an LLC or corporation.
- Liability: How much protection do you want over your personal assets? If you’d rather have a distinct separation between you and your business entity, you may want the protection of an LLC or corporation.
- Taxes and payment: How do you want to be paid? What tax deductions are you interested in? Do you like the freedom of taking a draw whenever you want, or would you prefer the predictability of a salary?
- Control: How much autonomy and decision-making power do you want? When you’re self-employed, you have complete control over your business, but when there are other shareholders or members involved, you may have to make concessions.
Consult a tax professional
As a business owner, it’s important to figure out whether you’re only an owner—or an owner and an employee. Which category you fall into affects how you pay yourself and pay your taxes.
To ensure you’re taking the right legal precautions, make sure you discuss your business setup and tax situation with a business accountant.