Compensation within Business Entities
How Business Owners Receive Money
Written by Jason Gordon
Updated at April 5th, 2023
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How is the owner of a business compensated?
The owners of a corporation may be compensated in two primary manners. The acceptable method of compensation depends upon the type of business entity and the role that the owner plays in the business.
Next Article: How are Businesses Taxed Back to: BUSINESS ENTITIES
What is pass-through compensation?
Some business entities allow business profits to pass through the business directly to their owners. These owners receive either a percentage of the profits based upon their ownership percentage or a percentage based upon a special allocation of business profits that differs from their ownership percentage.
What is Compensation through Dividends?
Other business entities (specifically corporations) compensate owners by distributing dividends from business profits. Unlike flow-through profits, payment of dividends is generally a decision by the board of directors and does not represent all profits of the corporation. That is, the corporation determines the amount of any dividends paid to shareholders and may retain any percentage of profits within the corporation.
- Note: A corporate employee who is also a business owner must receive a reasonable salary for her services to the corporation. Otherwise, a portion of any share of corporate profits distributed as dividends will be treated as salary. This makes a difference in how the funds are taxed to the individual. An owner of any other type of business entity does not receive a salary and is compensated by receiving a distribution of profits.
- Example: I am a shareholder and CEO of ABC Corp. I will receive a salary for my services as as CEO, and I will receive a dividend if any are paid to shareholders. Corporate business entities (or business entities taxed as corporations) require that an owner who also serves as an employee of the business to draw a salary from the business. The salary is separate from any distribution of dividends.
Discussion Question
Is it common for owners of a business to also serve as employees of the business? Are most owners of a business in the US employees of the business? Please explain. Practice Question: Frank and Judy are members of an LLC. Both Frank and Judy work in the LLC and each is a 50% owner. What other information do we need to know to determine how Frank and Judy are compensated?
- An LLC may be taxed as a partnership or corporation. This election will determine the possibility of compensating owners who work in the business. In a partnership-taxed LLC, members cannot receive a salary. They must be compensated as a draw from company funds. If the entity is taxed as a corporation, the members who work in the business must be compensated as employees. They can also be compensated with distributions of company profits or retained equity. To determine how Frank and Judy are compensated, you would need to know the tax election and whether each of them works in the business.
Related Topics
- Business Entities (Intro)
- Why is studying business entities important?
- Considerations When Forming a Business Entity
- Holistic (Detailed) Overview of Setting Up a Business Entity
- What are Business Entities?
- What is a Closely-held vs Publicly-held Business?
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What are the main types of business entity?
- What are the primary characteristics of business entities?
- What is Creation of a business entity?
- Where to Form a Business
- Incorporating in Delaware
- Forming an LLC in Nevada or Wyoming
- Creating a Company Offshore
- Promoter
- Promoter Liability
- De Jure Corporation
- Ultra Vires
- Brassplate Company
- What is Maintenance of a business entity?
- What is Continuity of a business entity?
- Business Continuity Planning
- Buy Sell Agreements
- Shotgun Clause
- Winding Up
- Dissolving a Foreign Qualification
- What is the Ownership structure of a business entity?
- Joint Stock Company
- Parent Company
- Subsidiary Company
- Wholly-Owned Subsidiary
-
Operating Subsidiary
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Holding Company
- State-Owned Enterprise
- Mutual Company
- Conglomerate
- What is Control of a business entity?
- What is Personal liability of owners of a business entity?
- Entity Theory
- Piercing the Corporate Veil
- What is Compensation of business owners?
- What is Taxation of a business entity?
- What is Sales & Use tax?
- What are payroll and self-employment taxes?
- What are the major characteristics of a Sole proprietorship?
- Uniform Partnership Act
- Uniform Limited Partnership Act
- Partnership Agreement
- At-Will Partnerships
- Responsibilities of Partners to the Partnership
- Silent Partner
- Funding the Partnership
- How are Partners Compensated
- Splitting Equity in an Industrial Partnership
- Terminating the Partnership
- Types of Partnerships
- What are the main characteristics of a General partnership?
- Tort Liability of General Partner
- What are the main characteristics of a Joint venture?
- What are the main characteristics of a Limited partnership?
- Family Limited Partnership
- Master Limited Partnership
- What are the main characteristics of a Limited liability partnership?
- What are the main characteristics of a Limited liability company?
- Forming an LLC
- Articles of Organization
- Operating Agreement or LLC Agreement
- Why You Need an LLC Agreement
- LLC Compensation of Members
- LLC Taxation
- Converting to an LLC
- What are the main characteristics of a Corporation
- Articles of Incorporation
- What to include in the Articles of Incorporation
- Corporate Bylaws
- Exiting the Corporation
- Dissenter's Rights
- What are the requirements to be an S Corporation?
- Non-Profit Organization
- NonProfit Business Entities
- Private Foundation
- A Detailed Explanation of the Sole Proprietorship
- Taxation of Sole Proprietorship
- A Detailed Explanation of the General Partnership
- 50/50 Partnerships: Never a Good Idea
- Publicly-Traded Partnerships
- A Detailed Explanation of the Limited Liability Company
- A Detailed Explanation of the Corporation
- Keepwell Agreement (Letter of Comfort)
- Personal Service Corporation Definition
- A Detailed Explanation of the Non-Profit Entity
- Public Limited Company (UK)
