How to Pay Owners in a Partnership: Why W-2 Feels Right (But Usually Isn’t)

January 12, 2026

When business owners form an LLC taxed as a partnership, one of the first questions that comes up is deceptively simple:

“How do I pay myself?”

For many, the instinctive answer is payroll.A W-2 feels clean. Legit. Structured. It’s how we’ve been paid our entire working lives.

Unfortunately, for partners in an LLC, it’s usually not the correct solution — and in many cases, it actually creates unnecessary tax cost, compliance issues, and confusion in the financials.

Let’s walk through why W-2 seems logical, why it’s typically incorrect for partnerships, and what does work instead.

Why Owners Default to W-2 (And Why It Makes Sense Emotionally)

Most business owners:

• Want consistency in pay

• Want taxes “handled automatically”

• Want their compensation to feel official

• Are trying to avoid surprises at tax time

Payroll appears to solve all of that in one move.

But partnerships are treated very differently under the tax code than corporations — and that difference matters.

The Core Rule: Partners Are Not Employees

In an LLC taxed as a partnership, owners are not allowed to be W-2 employees of their own business.

That’s not an opinion or a preference — it’s a structural rule.

What happens when partners are put on payroll anyway?

• Payroll taxes are withheld and paid by the business

• The partners still owe self-employment tax personally

• The same income is effectively taxed twice

• The financial statements become misleading

This is one of the most common “it looks right but isn’t” mistakes I see.

The Two Correct Ways to Pay Owners in a Partnership

Instead of payroll, partnership owners are typically paid in one (or a combination) of the following ways:

1. Owner Distributions (Balance Sheet Impact)

Distributions are withdrawals of equity.

• They do not hit the Profit & Loss statement

• They reduce the owner’s capital account on the balance sheet

• They are not an expense of the business

• Taxes are handled at the personal level

This method works well when:

• Cash flow fluctuates

• Owners take money as available

• Compensation doesn’t need to be perfectly consistent

Important note:Distributions do not reduce taxable income on their own — they are simply moving money that has already been earned.

2. Guaranteed Payments (P&L Impact)

Guaranteed payments are the partnership’s way of compensating owners for services rendered.

Think of them as: “Partner compensation that functions like pay — but follows partnership rules.”

Guaranteed payments:

• Do hit the Profit & Loss statement

• Reduce net income of the business

• Are subject to self-employment tax

• Are reported on the partner’s K-1

• Do not involve payroll or W-2s

This method is often ideal when:

• Owners want predictable compensation

• The business needs to reduce net income

• Partners are actively working in the business

• Clean financial reporting matters

Why Guaranteed Payments Are Often the Missing Link

Many owners choose between:

• “Payroll” or

• “Just taking distributions”

Guaranteed payments sit in the middle — and are often the most strategic option.

They:

• Reflect the reality of owner labor

• Reduce business net income appropriately

• Avoid payroll tax duplication

• Keep financial statements accurate

From a CFO perspective, they also allow us to:

• Structure compensation intentionally

• Align taxes with cash flow

• Avoid year-end panic adjustments

The Real Cost of “Just Putting Owners on Payroll”

When owners are incorrectly paid via W-2 in a partnership, I often see:

• Unnecessary payroll tax expense

• Monthly payroll software fees

• CPA cleanup work later

• Confusion at tax time

• Overstated expenses or misstated equity

And the worst part?Most owners did this trying to be responsible.

The Bigger Picture: Structure Drives Strategy

How owners are paid affects:

• Net income

• Tax liability

• Cash flow

• Balance sheet accuracy

• Long-term planning decisions

This isn’t just a compliance issue — it’s a strategy issue.

The goal isn’t to pay yourself somehow.The goal is to pay yourself correctly and intentionally.

Final Thoughts

If you’re an LLC taxed as a partnership and:

• You’re paying yourself via W-2

• Your income feels higher than expected

• Your books feel technically “right” but strategically off

…it’s worth revisiting how owner compensation is structured.

Payroll feels logical.But in partnerships, logic and tax code don’t always align.

Getting this right early — or correcting it thoughtfully — can save real money, reduce stress, and give you cleaner financials to grow from.

If you’re unsure which approach fits your business, this is exactly the kind of conversation a bookkeeper and CPA shouldbe having with you — proactively, not reactively.