How do Small Business Owners Pay Themselves?
Small owners have choices in how they pay themselves. The choices are tied into the business structure and company earnings. There are certain tax advantages with the various business structures. For example, if you’re a sole proprietor of a business, you can take an owners draw. The draw is money you pull from equity in the business – money that you’ve previously invested into the business.
If your business structure is a partnership the partners can draw a salary or receive distributions. Or each can do an owners draw. If your business is a corporation, you can receive dividends as corporate shareholders. Each method of payment includes its own specifics of how to pay taxes on the money.
Here’s the dilemma for business owners: the business is growing and you’d like to invest some of the profits back into it. But, you’ve been working long hours and need to earn money. Where’s the balance? As a business owner, how should you pay yourself? And how much?
If your business is a sole proprietorship, such as when you pay yourself as a freelancer, you can deduct expenses. You can also deduct the amount of your draw, or draws – the money you pay yourself back from your investment into the company. This money is not taxed when you do the draw, and it can be deducted as an expense.
If you’re a corporation (c corporation), the corporation will be taxed as a separate entity. The owner and shareholders may get dividends.
If you’re a single member LLC (limited liability company) you can also do a draw. The advantage is that as an LLC, your personal assets such as a home and vehicle, are protected .
If you’re a partnership, which is two or more owners, you are personally liable for business debts. Income in the form of draws or salaries can be tied into the percentage of money each partner has invested. That would be spelled out in the partnership agreement.
A salary can be based on revenue or can be a set amount in a guaranteed payment. That can be easily tracked through the separate business account. Paying yourself can be as simple as transferring money from the business to the personal bank account. But you have to be careful because you don’t want to be using a business account for personal use. A reasonable salary would be a moving target based on how much revenue is being generated. It can be a percentage of revenue. A salary can be paid on a structured schedule, such as bi-weekly or monthly.
What Mistakes Should I Avoid when Paying Myself as a Small Business Owner?
Set aside money to pay and file taxes at the end of the year.
For personal income tax, you should pay estimated taxes on a quarterly basis.
You must have a separate business bank account.
You should decide on a payment method before choosing your best setup for a business entity.
You need a rainy day amount to keep on hand for unexpected operational expenses, based on your financial statements and any guaranteed payments.
How much should you pay yourself as a business owner?
To determine reasonable compensation, many business owners use these figures as a basis for calculations: basic expenses, business’s performance/ profit, business plan for growth, your personal needs.
Use our Free ALIE to help you to see how much your expenses are, and what would be seen to be a reasonable salary to take from your business.
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