Paying yourself as a small business owner depends on various factors, including business structure and its stage of growth. It may not be in your mind to pay yourself while building a business, but familiarizing yourself with the concept can come in handy for later.
2 Ways to Pay Yourself as a Small Business Owner
Here are two ways you can start paying yourself as a small business owner.
1. From a Limited Liability Company (LLC)
An LLC is a business entity where you are an owner as well as a member of the LLC. This means you are not personally accountable for the company’s debts and any other financial or legal liabilities. Furthermore, the company pays its own taxes, and the law considers it a separate entity from the owner.
That said, here are several ways of paying yourself through an LLC.
Paying Yourself a Monthly Salary
The primary benefit of paying yourself a monthly salary like an employee is that you will have a regular income stream. This is a great way to meet your personal financial requirements. However, the amount of salary you pay yourself has to be realistic. Therefore, do some research to determine the average salary adequate enough in your industry for the amount of work you do.
Paying Yourself as an LLC Member
You will draw the profits earned during a single fiscal year if you opt to pay yourself as a small business owner. You will receive the same percentage as every other member of the LLC will as per the LLC’s operating agreement.
Paying Yourself While Working as an Independent Contractor
Do you have any specialized skill set that your organization demands? In that case, you can choose to work as an independent contractor for an LLC. For example, you have a background in accounting. You can work as an independent accountant helping the company and the clients with their accounts and finance management.
Withdrawing wages as an independent contractor will allow your company to stay within its budget. Plus, you will be responsible for paying taxes under the self-employment tax bracket.
Receiving Distributions from Your LLC’s Profits
An LLC member receives distributions from its earnings. The distribution amount depends on the amount invested by each member and the terms and conditions stated within the LLC’s operating agreement.
This agreement states the percentage of earnings each member will receive, along with the schedule of profits distribution. However, LLC does pay income tax on the percentage of profit you receive as a member. However, the amount of tax will depend on the amount you have received when paying yourself the profits.
2. Paying Yourself Through Owner’s Draw
An owner’s draw refers to the money you can pay yourself as a sole business owner or a co-owner of a Sole Proprietorship, Partnership, or LLC for personal use. However, the owner’s draw rule does not apply to corporations such as S Corp as they take profits in the form of dividends and distributions.
The owner’s draw distribution depends on the percentage of ownership you have in the company. Additionally, the owner’s draw is expenses deducted from the company’s earnings. Therefore, you as a business owner must pay taxes on such earnings through income tax returns.
An owner’s draw is how you can pay yourself as a small business owner rather than a monthly take-home salary. You can withdraw this amount via a cheque from your corporate bank account. Thus you can pay for the expenses when the bank account receives a funds deposit.
This is unlike the case where an employee gets a salary via payroll services after deducting employment tax.
From an accounting perspective, withdrawing money from the company reduces its capital account. This happens because you take out funds from your own equity as an owner. An owner’s equity is the sum of money you invested in the business. Therefore, every time you withdraw money, you lower the amount of your equity as an owner of the company.
The owner’s draw is non-taxable on the company’s income. Rather the taxes are applicable on your income tax returns.
Should You Pay Yourself a Salary?
There are several factors to consider when paying yourself as a small business owner.
The business type you own plays a vital role in determining the payroll process when paying yourself as a small business owner. The business structure will indicate your payment style relevant to your business.
Owners of LLCs, sole proprietorships, and partnerships fall under the classification of self-employed. Therefore, you will pay yourself through the owner’s draws. This means you will not be paying yourself a regular salary.
Instead, you will be taking out funds from the company for your personal use. In case your business is a corporation, then you will have to pay yourself a wage. This will require you to engage in its day-to-day activities or operations.
Amount of Payment
Once you have determined the method of payment suitable for your business type, it is time to calculate how much you should pay yourself. According to the Internal Revenue Service (IRS), you must make a reasonable payment to self as a small business owner.
Typically, reasonable pay will be the amount you would pay to an employee or contractor when hiring their services. You may also consider other factors when determining the amount of money you must to yourself. These include the following:
- The complexity of your business
- The duties you perform as an owner
- Your cost of living
- The volume of your business
- The time you invest in the company etc
The amount of the right pay to withdraw from the company also depends on your profits and losses. This will help evaluate if your company is generating any profits. Once you have the information, you must deduct the payment you are making to yourself from the profits earned.
However, you must do this after deducting business expenses such as business supplies, salaries, rent, utilities, etc.
The Payment Schedule
If you are a self-employed business owner running the entire show, then you must think about establishing a schedule of payment. For instance, you can decide to pay yourself weekly, bi-weekly, and monthly. You can even find out your state’s rules on the payroll schedule.
Therefore, you must get in touch with the Department of Labor to find out the payroll schedule your resident state falls under.
Time to Get Paid
It is now finally time to pay yourself as a small business owner. You can do so either by writing a cheque or making direct online funds transfer into your personal bank account.
How Much Should You Be Paying Yourself as a Small Business Owner?
Once you have decided that you will be paying yourself, it is time to decide a reasonable amount. On average, a self-employed entrepreneur earns about $68,000 annually. However, if you are paying yourself via an owner’s draw, the pay should come from the company’s net profit. This is your company’s revenue minus all its operational expenses.
This will ensure that you have met all your company’s financial obligations, including employees’ pay (if you have any). You can have to ensure you have paid all your company’s obligations before you pay yourself.
Remember the thumb rule to fix a percentage of the company’s profit that you will pay yourself as a small business owner. This way, your compensation will continue to adjust as per the company’s performance. If your business is doing great and the profits are high, you will be able to withdraw a higher amount due to the fixed percentage.
Mistakes To Avoid When Paying Yourself as a Small Business Owner
Here are three mistakes that you must avoid as a business when paying yourself.
Mixing Your Personal and Business Finances
One of the most critical and basic tenets of running a business is never to mix your personal and corporate finances. Always keep the business account separate from your day-to-day personal accounts. Do not make the classic mistake of using your business’s credit card to pay personal expenses.
Similarly, do not forget to transfer your owner’s draw or pay from your business account to your personal account. In both of the above-mentioned scenarios, you will end up complicating the accounting and hurt your financial history.
Forgetting to Budget for Taxes
In case you are paying yourself as a small business owner via owner’s draw, always remember to keep a portion of each draw aside to pay your taxes later. This is because you will only be paying taxes once every quarter of a year.
You can use accounting management software to calculate how much you must keep aside for paying your taxes later. Failure to budget your taxes will most likely result in penalties and huge tax bills.
Not Paying Yourself or Paying Inconsistently
It is ok not to pay yourself right from the start of the business, as you would want to ensure that everything is running smoothly with enough cash flow. However, you must ideally schedule a payment plan as part of your initial business strategy.
The financial projections you design much include how much you will pay yourself as well as when you will be paying yourself. Not taking it out or being inconsistent can complicate your entire financial cycle, and it will be hard for you to keep track of how much you should have paid yourself later. This will eventually result in possible faltering at paying taxes.
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