Starting a cannabis business is exciting, but it also comes with its own set of challenges. One of the most important decisions that business owners need to make is how to pay themselves. How you pay yourself will depend on the entity type of your business, and each entity type has its own tax implications, which can affect how much money you take home at the end of the day. In this blog post, we will discuss the different entity types in the cannabis industry and how they impact the way you pay yourself. This decision is affected by the type of entity the business is, as well as other factors such as the business’s financial situation and the owner's personal financial needs.
To help you make an informed decision, Redbud Advisors will explore the various payment options available to business owners and the factors to consider when choosing a payment method. Whether you are a sole proprietor, LLC, S corporation, or C corporation, we will break down the pros and cons of each payment option and how they can affect your personal finances and the financial health of your business. By the end of this post, you will have a better understanding of how to pay yourself and which payment method is the best fit for your business.
Sole Proprietorships: How to Pay Yourself
If you operate a sole proprietorship in the cannabis industry, you are not considered an employee of the business, and you do not receive a regular paycheck. Instead, all profits and losses of the business flow through to your personal tax return on Schedule C. You pay self-employment taxes on the net profit of your business, which includes both your salary and any profits earned by the business.
To help you pay yourself from a sole proprietorship, you can take what is called a "draw" from the business. This means that you can take money out of the business bank account for your personal use. However, it is important to keep accurate records of these withdrawals and make sure that you do not take out more than what the business can afford.
Partnerships: How to Pay Yourself
If you operate a partnership in the cannabis industry, the profits and losses of the business flow through to the individual partners. Partners pay self-employment taxes on their share of the net profits of the business. Like with sole proprietorships, partners are not considered employees of the business and do not receive a regular paycheck.
In a partnership, partners can take a draw from the business, similar to how sole proprietors do. However, it is important to note that draws are not considered to be a salary, and partners must still pay self-employment taxes on their share of the business profits.
Limited Liability Companies (LLCs): How to Pay Yourself
LLCs are flexible entities that can choose how they are taxed. LLCs with a single member are taxed as sole proprietorships, and LLCs with multiple members are taxed as partnerships. However, LLCs can also choose to be taxed as a corporation, which we will discuss later in this post.
If your LLC is taxed as a sole proprietorship, you can take a draw from the business, similar to how sole proprietors do. If your LLC is taxed as a partnership, you can take a draw, but you must still pay self-employment taxes on your share of the business profits.
S Corporations: How to Pay Yourself
S corporations are entities that allow business owners to avoid paying self-employment taxes on a portion of their income. Business owners who operate as S corporations must pay themselves a reasonable salary, and only the salary portion is subject to social security and medicare taxes (aka payroll taxes). The remaining income is distributed as a draw and is not subject to self-employment taxes.
If you operate an S corporation in the cannabis industry, you must pay yourself a reasonable salary, based on the services you provide to the business. This means that you cannot pay yourself an unreasonably low salary in order to avoid paying self-employment taxes. The IRS provides guidelines for what is considered a reasonable salary based on industry standards and job responsibilities.
C Corporations: How to Pay Yourself
C corporations are entities that are subject to double taxation. The corporation pays taxes on its profits, and shareholders pay taxes on any dividends received from the corporation. As an owner of a C corporation in the cannabis industry, you can pay yourself a salary and receive dividends. The salary portion is subject to social security and medicare taxes, while the dividend portion is not.
If you operate a C corporation, you can pay yourself a salary based on the services you provide to the business. Like with S corporations, you cannot pay yourself an unreasonably low salary in order to avoid paying self-employment taxes.
Conclusion
How you pay yourself as a business owner depends on the entity type of your business. Sole proprietors and partners can take a distribution of profits, while LLC members can be paid a salary or receive a distribution of profits. S corporation shareholders must receive a reasonable salary for their services, and any profits distributed as dividends are not subject to employment taxes. C corporations can pay salaries and issue stock to shareholders, but they are subject to double taxation.
Taking the time to understand your options and work with a professional to make informed decisions can help you maximize your personal income while keeping your business financially healthy.
At Redbud Advisors, we specialize in helping cannabis businesses navigate complex tax issues and make informed decisions about their finances. Our team of experts can provide personalized guidance on how to pay yourself and structure your business for maximum tax efficiency. Contact us today to learn more about how we can help you achieve your financial goals.
