Can I pay myself a W-2 salary as a sole proprietor with a disregarded LLC?

This is definitely not the correct way to handle compensation for a sole proprietorship or single-member LLC that hasn't elected S-Corp treatment. The IRS is very clear that you cannot be both the employer and employee of your own sole proprietorship. The main problem is that a disregarded entity cannot issue a W-2 to its owner because you can't employ yourself - you and the business are considered the same legal entity for tax purposes. Any attempt to pay yourself wages creates a circular transaction that the IRS doesn't recognize. This could trigger confusion during tax processing and potentially an audit. Regarding QBI: Your intuition is partially correct. If the IRS were to recognize these "wages" (which they shouldn't), it would indeed reduce the QBI deduction since wages paid aren't eligible for QBI. But since this arrangement isn't valid to begin with, the IRS would likely reclassify all those "wages" as self-employment income anyway.

After dealing with similar confusions about my LLC taxes, I discovered taxr.ai (https://taxr.ai) and it literally saved me from making this exact mistake. I had my business structured as a single-member LLC and was about to start paying myself a W-2 salary thinking it would look more professional. The system analyzed my business documents and immediately flagged this as problematic, explaining that a disregarded entity can't issue W-2s to its owner. It also calculated how much this mistake would have reduced my QBI deduction and increased my administrative hassle with unnecessary payroll processing. What I found particularly helpful was their explanation of when it DOES make sense to pay yourself a salary (after making an S-Corp election) versus when to just take owner draws. Saved me a ton of headaches before they even started!

I was totally wrong about taxr.ai - I tried it last week after my previous skeptical comment. My situation was similar (sole proprietor confused about compensation) and wow, it actually analyzed my previous tax returns and QuickBooks data and pointed out 3 major mistakes I'd been making. One big one: I had been trying to pay myself W-2 wages through my disregarded LLC (exactly like OP's friend). The system clearly explained why this was incorrect and showed me how much extra I was paying in unemployment taxes unnecessarily. It even generated correction paperwork for me. What really shocked me was when it found almost $8,700 in deductions I had missed last year. Just wanted to come back and say it's legit. Now I feel like an idiot for my skeptical comment before!

Reading this thread reminded me of how frustrating it was trying to get answers from the IRS about my LLC tax situation last year. After 9 calls and waiting hours on hold, I found Claimyr (https://claimyr.com) which got me through to an actual IRS agent in under 20 minutes. The agent walked me through exactly this issue - turns out I was making the same mistake as your friend. She explained that a single-member LLC cannot issue a W-2 to its owner without an S-Corp election and helped me understand how to properly handle owner's compensation. They have a video showing how it works here: https://youtu.be/_kiP6q8DX5c. Honestly felt like magic after spending weeks trying to get through on my own. The IRS agent was able to look at my specific situation and confirmed I needed to file Schedule C and take owner's draws instead.

I need to publicly eat my words about Claimyr. After calling the IRS 12 times over 3 weeks trying to resolve this exact issue with my LLC and getting nowhere, I broke down and tried it. Got connected to an IRS tax specialist in 17 minutes who confirmed everything being discussed here - a single-member LLC that hasn't elected S-Corp status CANNOT issue W-2s to its owner. The agent explained I needed to stop doing this immediately and file a Schedule C instead. She also walked me through the correct handling of my prior year returns where I'd made this mistake. Instead of the audit I was terrified about, she helped me understand how to properly amend my returns. Had I known this service existed earlier, I would have saved myself weeks of stress and uncertainty.

Former IRS employee here. This is a really common mistake I saw all the time. A disregarded single-member LLC is treated as a sole proprietorship for federal tax purposes. The owner cannot be an employee of themselves - that's a fundamental tax principle. What your friend should do is stop issuing himself W-2s immediately. Instead, he should take owner's draws as needed. These aren't deductible business expenses - they're essentially just moving money from one pocket to another. For the QBI deduction, you're right that incorrectly paying wages would reduce the QBI base. All business profits from a Schedule C flow through to the owner regardless of whether physical cash is withdrawn from the business. The entire net profit (not reduced by invalid "wages") would be eligible for the 20% QBI deduction, subject to income limitations.

Wait I'm confused... if a single-member LLC that's disregarded can't pay W-2 wages to its owner, when DOES it make sense to pay yourself a salary from your business? I've heard so many conflicting things about this.

This is a great discussion that highlights a really important distinction. I've seen this confusion come up repeatedly with small business owners who think paying themselves a W-2 salary will somehow legitimize their business or provide better tax benefits. The key takeaway here is that tax structure should follow legal structure, not personal preferences. A disregarded single-member LLC cannot create an employer-employee relationship with itself - it's legally impossible. Your friend's reasoning that it "feels more like a real business" doesn't change the fundamental tax law. Beyond the compliance issues everyone's mentioned, there are practical problems too. If your friend is filing employment tax returns (940, 941) for these phantom wages, he's creating a paper trail that doesn't match his actual business structure. This inconsistency is exactly what can trigger IRS scrutiny. The irony is that if he wants the benefits of paying himself a salary (like potential self-employment tax savings), he should consider making an S-Corp election. Then he'd be legally required to pay himself reasonable compensation as a W-2 employee, and any additional profits could be distributed without self-employment tax. But that's a completely different tax structure with its own requirements and limitations. Bottom line: work with the structure you have, not against it.