On average, small American businesses make $53,000 in revenue per year. But don’t mistake that for the actual amount that the owners take in; often, they’ll pay themselves, which means that the company’s revenue is separate from their own income.
If this is a new concept to you, then now you might be wondering about how to pay yourself as a business owner. Why should you do it, and what are the steps you need to take? This article will outline everything for you so it’s not a difficult task to do.
Why Pay Yourself as a Business Owner?
So why should you even go this extra step and pay yourself? Well, for one, it recognizes your contribution, and it reflects the value of your work. As a result, it can boost your morale and motivation, which can then empower you to grow your business.
Also, it helps you separate business and personal finances. If you mix personal and business finances, it can complicate bookkeeping; you may even run into tax or legal issues. Paying yourself establishes a clear boundary, making finances easier to manage and audit.
By paying yourself, you’ll ensure financial stability, and this can reduce personal stress. In addition, it’ll force you to think critically about cash flow, profitability, and budgeting, making you more proactive about the management of your company’s financial health.
Another reason to pay yourself is that you may enjoy tax benefits. For example, S-corporation owners can take a mix of salary and distributions to reduce payroll taxes (more on this later).
Lastly, you can avoid IRS scrutiny, as they expect you to compensate yourself appropriately. So if you pay yourself a “reasonable” salary, you can avoid penalties or audits.
How to Pay Yourself as a Business Owner
In general, there are two ways to pay yourself as a business owner: through a salary or a draw. In some cases, you can even use a combination of the two.
However, paying yourself as a business owner will depend on your business structure, financial situation, and tax obligations. We’ll give you a general guide based on common business types.
Sole Proprietor
Sole proprietors are personally responsible for all business operations, as well as profits and liabilities.
To pay yourself, you can take an owner’s draw by transferring money from your business bank account to your personal bank account. The draw would come from net profits, which is the resulting money after expenses are paid.
What’s great about this setup is that you don’t need to set up payroll or withhold taxes. However, you’re responsible for quarterly estimated tax payments.
Profits are taxed as personal income on your Schedule C (Form 1040). Plus, you must pay self-employment taxes (Social Security and Medicare).
Partnership
In a partnership, everyone shares the profits and losses as per the partnership agreement.
To pay yourself, you take distributions (or draws) based on your ownership percentage or the agreement. Each partner pays taxes on their share of the profits, regardless of whether they withdraw them.
Taxes are reported on Schedule K-1 and are included on each partner’s personal tax return.
In this scenario, you should keep enough money in the business account to cover operating costs and any unexpected expenses that may arise.
Limited Liability Company (LLC)
LLCs offer flexibility, so the way you pay yourself will depend on how the LLC is taxed.
In a single-member LLC, the company is treated like a sole proprietorship for tax purposes. You’d take owner’s draws from the business profits.
A multi-member LLC is treated like a partnership. The LLC members take distributions according to the ownership agreement.
Outside of single or multi-member LLCs, you can have your business taxed as either an S-corporation or C-corporation. In the former, you’d pay yourself a salary and can take dividends from the remaining profits. In the latter, you’re treated like an employee and will receive both a salary and potential dividends.
Regardless, LLC members pay taxes on profits through their personal tax returns. If your LLC’s taxed as a corporation, then you must follow corporate tax rules. Here, salaries are subject to payroll taxes, but distributions aren’t.
On that note, if you want to form an LLC, you should use our free business registration service. Just take care of the state fee, and you won’t have to pay a penny more for us to get your LLC registered.
S-Corporation
S-corporations are popular because there are many associated tax benefits. However, you should be aware that there are strict rules.
To pay yourself, you should take a reasonable entrepreneur salary through payroll. It should reflect what you’d pay someone else to do your job. If there are additional profits, they can be distributed as dividends.
Your salary is subject to income tax and payroll taxes. Dividends are also subject to income tax, but not payroll taxes, which means you can get significant tax savings.
C-Corporation
C-corporations are considered separate legal entities, so you’d be an employee of the corporation. You should pay yourself a salary through payroll, but you can also receive dividends from profits.
In a C-corp, your salary is also subject to payroll taxes. And dividends are taxed at both the corporate and personal levels, leading to “double taxation.” For this reason, you should limit dividend payments and rely on a salary to avoid double taxation.
Pay Yourself Wisely
Knowing how to pay yourself as a business owner can really reduce your financial obligations, and ultimately, you’ll find yourself with more money in your pockets.
It’s always a good idea to set aside a good chunk of your income for taxes and to track your finances through accounting software like QuickBooks. Plus, you should make estimated tax payments, especially if you don’t receive a formal paycheck with tax withholdings. And if you ever have any questions, consult with a tax or legal professional to ensure you won’t face any penalties or fines.
Sign up with Business Anywhere now to use our free business registration service. We also offer registered agent and virtual mailbox services.
