How Do I Pay Myself as a Business Owner?
Running a business can be a very exciting adventure. If you are like most business owners, there are probably several different reasons you decided to start your own enterprise: the ability to control your own schedule, the ability to create something you are proud to call your own, and the ability to provide value to the world around you. Of course, there is probably one other important reason you decided to launch: getting paid.
As soon as your business begins to have cash flowing into and out of it, your financial situation will become measurably more complicated. Sure, your business managed to make $10,000 last month, but does that mean that those funds are all available for you to spend? How much is your take-home pay and how much taxes do you owe? As you might expect, these questions do not always have very clear answers.
One of the most common things business owners ask themselves, especially sole proprietors and LLC members, is how and when will I get paid?
Defining Your Enterprise
From the moment your business earns any revenues or pays any expenses, you will be officially operating as some sort of enterprise. If you have not taken any action to formalize your business (which we strongly recommend you do), the IRS will “default” to treating your business as a sole proprietorship. According to estimates from the Tax Foundation, there are about 23 million sole proprietors in the United States.
The way you classify your enterprise (which can involve a bit of paperwork) will directly affect how your activities are taxed and how you will be able to pay yourself. Sole proprietorships can often be easily converted into limited liability companies (LLC), which can help protect you from some of the financial risks that come with running a business.
Other possible options include an S corporation, a C corporation, and a partnership. Each classification has different advantages and disadvantages and a tax professional is usually the best partner to help you determine which structure is right for your business. Regardless, it will be important to understand how your business is classified and whether you have the right to directly draw from your funds to pay personal (non-business-related) expenses.
Defining Your “Salary”
When you are working for someone else, your salary is usually pretty straightforward. Most of the time, you will have signed a contract that lays out a clear payment schedule and, ideally, your questions can be answered by the contract.
When you are working for yourself, things can get a bit murkier. Essentially, you will be required to either take an owner’s draw, pay yourself a salary, or some combination of the two.
With an owner’s draw, you can simply draw from your business checking account and transfer the funds to your personal account. If your business accounts and personal accounts are currently connected, then every personal expense you accrue will be effectively treated as an owner’s draw (however, for many reasons, we strongly recommend separating these expenses).
With a salary, you will have a predetermined wage that is paid at set intervals. Structurally, your salary will be paid to you as if you were an ordinary employee. The salary approach offers a bit less flexibility but is structured in a way that is simpler and can also give you additional asset protection.
Think of it this way—Elon Musk is the founder of Tesla, but that doesn’t mean he has the right to withdraw from the company coffers whenever he wants. Because he made the company into a C corporation, he is now limited to drawing a salary and accumulating wealth through stock appreciation. This sort of structural logic can apply to all businesses, regardless of size.
Getting Paid: What You Need to Do
The exact ways in which you, the business owner, get paid will depend on the choices you made during the steps mentioned above. If you are running a sole proprietorship, LLC, or partnership you will need to use the “owner’s draw” approach where you will simply transfer funds from your business account to your personal account (which can be done using QuickBooks and other tools) either at regular intervals or as needed.
If your business is a C Corporation, you will need to set up payroll and pay yourself as an employee of the company. If you are an S Corporation, this can be the most complex structure because you have a choice. You are required to pay yourself a “market” salary but you also have the option to take a “shareholder’s draw.” Your tax accountant can help you determine how much to pay yourself and how much to draw based on your personal tax circumstances.
Deciding How Much to Pay Yourself
Naturally, you probably want to keep as much money for yourself as you reasonably can. However, “maxing out” your draws or salary can have consequences and take money away from your business, which could potentially be used for growth. You also want to be sure that you have sufficient funds left in the business to cover upcoming expenses or debt payments. You are also required to pay income taxes so making sure you set aside enough to cover upcoming tax liabilities is important (we recommend funneling a percentage of your profit over to a savings account).
It is also important to understand tax requirements. In the case of a C or S Corporation, you are required to pay yourself the salary that you would receive if you were working in a similar company in your industry. They want you to pay yourself a market rate. It can be prudent to pay yourself a lower salary, but make sure you check with your tax accountant to be in line with tax regulations.
This can all seem a bit complicated, but once you have a plan in place it will be smooth sailing. Working with a small business accountant will help make it easier to compare your options and find a solution that works for you.