Knowing how to pay yourself as a business owner is complicated and can’t be ignored. Many factors play into this, including the stage of your business growth and your kind of business structure. However, you can do it and also keep your business safe.
Owner’s Draw vs Salary
There are two ways to consider how to pay yourself and they are either the owner's draw or a salary. Both have their pros and cons and here’s a look at the owner’s draw vs salary.
Owner’s Draw
You can withdraw money from your business up to the amount that you have put into it, otherwise known as owner's equity. This comes out of business profits. Taxes aren't due upfront whenever you do this but keep meticulous records. Taxes will be due when you file at the end of the year.
Pros
You have the flexibility of drawing only when the business performs well enough. That means you can leave the business alone when it needs everything it can get in harder times.
Cons
You'll have to budget for your tax bill when the year is over.
Salary
A salary might be an IRS requirement of an S- or C-corp, as you might be expected to pay yourself the wages that an equivalent industry professional would make. This would be a regular salary just like any non-owning employee would get, complete with tax withholdings.
Pros
A salary is a predictable recurring expense your business can budget for. The taxes will be deducted upfront so there are no surprises later on when it comes time to pay your taxes.
Cons
Your salary will be inflexible for the business when times go bad, as you have to follow the rules about reasonable compensation.
How to Pay Yourself from Your Business
Your company tax structure might narrow your options or even determine how you have to pay yourself from your business. Knowing the various structures and how they impact owner pay helps you navigate these complicated matters.
How to Pay Yourself from an LLC
How to pay yourself single-member LLC profits is best down through an owner's draw. An LLC is a pass-through entity. That means the taxable income of a business gets allocated straight to owners. They pay the taxes when they file their returns. Owner's draws are something you do to distribute funds as you see fit, so you can choose to do it only when your business grows.
How to Pay Yourself from a Partnership or Sole Proprietorship
Owner's draws are also the ideal way to pay yourself through a sole proprietorship or partnership. Decide how much money you'd like to take for your own personal budget, figure out what your business needs, and then calculate the difference. Divide that number by 12 to get a monthly allotment for personal use.
How to Pay Yourself from an S Corp or C Corp
If your business operates as either an S or C corp, then there might be three distinct processes you can use to pay yourself for being an owner. The IRS has specific rules that determine how much you're able to pay yourself for being a business owner, and the rules are different for each kind of corporation, and thus it’s very important for you to understand the differences.
S Corporation
How to pay yourself s corp starts with the fact that owner salaries are considered to be normal business expenses. Net profit not used as a salary or draw gets taxed at corporate rates that are typically lower than personal income taxes. That is because an S corp is a form of partnership where income is relayed to shareholders as dividends.
C Corporation
C corps differ from other tax structures mentioned because double taxation happens. It hits the business on the profits and then again on owners when they pay taxes on their dividends. The C corp is taxed at a corporate level itself at first and then again at an individual level when shareholders get their dividends.
How Much to Pay Yourself
Your business is intended to personally profit you, but if you pay yourself too much, then you might also put your business in harm's way. Make sure it's profitable first. Balance your personal needs with your budget's needs for operating expenses, emergency funding, and marketing. Cash flow disruptions sink 80 percent of new companies.
Conclusion
How do you pay yourself as a business owner? That depends on your company structure and growth stage. You need money for personal expenses and the costs of living, but you also don't want to hurt your small business from growing. If you want help with managing your small business accounting, then Lewis CPA is here to help you with all your needs.
