How To Pay Yourself As A Business Owner
The Fruits of Your Labor
How you pay yourself as a business owner depends on the business structure. The simplest case is sole proprietors, but there are other formats we discuss below.
Paying yourself correctly and understanding how the process works as a business owner can set you up for success. You can use your salary as motivation and manage your finances more effectively.
Choose Owner’s Draw Or Salary
Company owners can choose between two ways to pay themselves: owner’s draw or salary. Each has pros and cons.
Owner’s draw is when you take profits out of your business as, and when, you need them. Sole company owners can take all the profits for themselves. Those who share ownership can only take as much as their share.
You do not need to pay taxes immediately when you draw money from your business’s profits. However, you should always set money aside to pay them in the future.
A salary is where you pay yourself as if you were a company employee, including withholding taxes from your paycheck. You must adopt this approach under certain business structures, as we will detail below. Your salary must be comparable to what other people get paid for doing the same job as you in your industry. Too high, and it could indicate tax avoidance behavior.
Owner payments pros and cons
You can also use other methods to take money out of your business, including distributions and dividends. We explain more about these below.
How To Decide Which Method To Use To Pay Yourself
Several factors determine the method you use to pay yourself.
The most important is business structure. You cannot use some payment methods under some LLC structures.
You can only take owner’s draw if you are a sole proprietor, partnership, or LLC taxed in a regular way. Owners of S-corps, C-corps, and LLCs taxed as a corporation must take a salary.
You should also consider the stage of your business. Founders don’t usually want to take any money out of their companies during the early stages. Then, once cash flow improves, they consider drawing down funds and transferring them to their personal bank accounts.
Therefore, you should consider which format is best for you from an operating perspective. Salaries aren’t a good option when finances are tight, but they make sense when profits and cash flow are rising, predictable, and stable.
You should also consider your personal financial situation. Many entrepreneurs live lean lives when they first start up, living in their offices and avoiding car ownership. This way, they can reduce their personal expenses to a minimum to support their businesses. However, others don’t find this lifestyle appealing. However, they can sometimes cut too close to the bone.
You will need to consider how much money you need to meet your financial obligations and survival needs. That’s the minimum amount you must pay yourself from your firm. Failing to pay yourself enough can make it harder to get small business financing.
How Much Should You Pay Yourself?
Once you know which method you will use to pay yourself, you need to work out how much. When settling on a figure, decide how much your business and household need.
Drawing too much money from your business can:
- Make it harder for you to pay necessary expenses at the right time
- Draw down on your rainy day fund (money you need in your account to cover expenses when business is slow)
- Reduce your ability to reinvest in your firm to develop and improve it
Considering these factors, you’ll need to work out how much you can draw down reasonably. Accountants and remote bookkeepers can show you how to stop guesstimating your cash flow and map it out more accurately. Depending on your industry, they can advise on how much money to set aside for a rainy day. You might need extra cash for 30, 60, or 90 days of expenses.
You should also consider what you need to spend money on in the future to make your business better. These are funds you set aside for new marketing ideas, expert consultants, or additional machinery for your plant.
On the flip side, you should balance business concerns with your household needs. Anything you pay yourself must cover obligations such as the mortgage and day-to-day living expenses, including food and heating. You’ll also want to have sufficient funds set aside to finance your retirement.
Start-up businesses generate less revenue. That’s why founders often live lean financial lives. They avoid expensive obligations until their businesses generate the cash to pay for them.
More established business owners can afford to take a balanced approach. They pay themselves enough to meet regular or extravagant household expenses once their financial position improves.
The average entrepreneur earns around $68,000 annually, a little more than the national median wage of $54,132. New entrepreneurs may want to pay themselves less than this figure, depending on how capitalized it is.
Owners who draw money from profits should pay their employees first before themselves. Workers are an obligatory expense, just like suppliers and contractors. Paying yourself a percentage of your profits – i.e. 20 percent – lets your pay rise and fall in line with your performance.
The following table describes how you should pay yourself depending on your structure.
Paying yourself as a sole proprietor, LLC, or corporation
While these payment methods might sound simple, it takes significant work and attention to detail to ensure all the numbers add up. Therefore, always talk to a professional bookkeeper, remote CFO, or accountant about your situation. They can ensure you pay the correct and fair tax based on your circumstances using advanced software, such as Gusto Payroll.
Mistakes Business Owners Make When Paying Themselves
Of course, business owners don’t always get everything right. Many make mistakes when paying themselves that cost them dearly in the long run.
Fortunately, you can avoid these if you know what to expect.
Mistake #1: Failing to set money aside for taxes
Business owners with cash on hand often want to spend it immediately, particularly if they see an opportunity to profit. However, these practices can make it more challenging to meet tax payment obligations later on.
Therefore, always set aside a reasonable sum for tax expenses. Do this as you go along to avoid a mad rush the month or two before the tax due date.
Mistake #2: Mixing your personal and business finances
Many business owners also make the mistake of mixing personal and business finances. Only use your business credit card for business expenses. Don’t use it to buy gifts for your family. Failing to observe strict separation can make it harder to get a loan. It can also lead to severe accounting complications requiring forensic work by a specialist, increasing your costs.
Mistake #3: Failing to pay yourself
Famous entrepreneurs talk about how they don’t pay themselves because they commit themselves fully to their vision. However, that’s not how every business leader should operate. It is not an all-or-nothing game.
Your compensation should be a part of your business plan. You need something that will motivate you and support the lifestyle you want. Your salary or owner’s draw should cover your expenses so you can fulfill your executive function.
Regardless of the method you choose to pay yourself, it should be fair. Give yourself consistent sums of money regularly to manage your household and business.
At the same time, keep one eye on your business. Ensure you have enough money for a rainy day and adequate cash flow to support your expansion and R&D plans.
Always talk to an accountant or remote bookkeeper if you are unsure of the details. They can help you figure out what you need to pay, now and in the future.