Running your own business is exciting, isn’t it? You get to call the shots, set your own schedule, and, most importantly, decide how much to pay yourself. But wait… how do you actually pay yourself? Is there a “right” way to do it? If you’ve ever found yourself wondering whether to take a salary, withdraw money as needed, or just hope for the best, you’re in the right place.
Let’s break it down in a way that makes sense, no complex jargon, no confusing tax lingo, just straight talk about how to make sure you get paid without hurting your business.
First Things First: Your Business Structure Matters
Before you even think about cutting yourself a paycheck, you need to know how your business is structured. Why? Because your legal setup determines the smartest way to take money out of your business.
- Sole Proprietor or Single-Member LLC? You and your business are legally the same entity, so you’ll likely pay yourself through an owner’s draw.
- Multi-Member LLC or Partnership? You’ll also take an owner’s draw, but it gets a little trickier with profit distributions.
- S-Corporation or C-Corporation? If you’re set up as a corporation, the IRS expects you to take a reasonable salary. That means you’ll need to process payroll, just like an employee.
Not sure which one applies to you? If you’re just starting out and haven’t made a specific election, you’re probably a sole proprietor by default.
Best Practices for Paying Yourself the Smart Way
Now that you understand your business structure, let’s talk about best practices for ensuring a smooth and financially responsible way to pay yourself:
- Keep Personal and Business Finances Separate. Always use a business bank account for transactions and transfer your salary or draw it into your personal account.
- Set Up a Regular Pay Schedule. Even if you’re taking an owner’s draw, consistency helps with budgeting and taxes.
- Simplify Financial Management with the Right Tools. Top accounting software can help manage payroll, track taxes, and organize financial records, making it easier to keep your business finances in order.
- Plan for Taxes Before Tax Season. Don’t wait until April to think about taxes, set aside a portion of your income throughout the year.
- Reevaluate Your Pay as Your Business Grows. As your profits increase, adjust your salary accordingly.
Using the right financial tools can make a huge difference when managing payroll and tax responsibilities. Investing in top accounting software ensures your income and business finances stay on track, helping you stay compliant while minimizing errors.
Salary vs. Owner’s Draw: What’s the Difference?
So, now that you know your business type, let’s talk about the two main ways to pay yourself: salary and owner’s draw. They’re not the same, and picking the wrong one can mean unnecessary taxes, or worse, IRS trouble.
- Salary (W-2 Income): If you’re running an S-Corp or C-Corp, the IRS expects you to take a salary. That means you’ll set up payroll, withhold taxes, and issue yourself a paycheck just like you would for an employee. This method is great because it keeps things clean and predictable.
- Owner’s Draw: If you’re a sole proprietor or an LLC, you don’t “pay” yourself a salary in the traditional sense. Instead, you take an owner’s draw—basically, transferring money from your business account to your personal account. No taxes are withheld upfront, but you’ll need to set money aside for tax time.
Still not sure which one to choose? Here’s an easy rule of thumb: If you’ve got a corporation, a salary is usually required.
If you’re an LLC or sole proprietor, you’re likely going with a draw.
How Much Should You Pay Yourself?
Alright, now comes the big question, how much should you actually pay yourself? You don’t want to take too much and leave your business struggling, but you also don’t want to live on ramen noodles forever while your company grows.
Here are some things to consider:
- Business Revenue & Expenses: Before deciding on a paycheck, look at how much your business is bringing in and what it needs to cover expenses.
- IRS “Reasonable Compensation” Rule: If you own an S-Corp or C-Corp, you can’t just take everything as distributions to avoid taxes. The IRS requires you to take a “reasonable salary.” So, what’s reasonable? Think about what someone in your industry with your role would typically earn.
- Reinvestment Needs: If you’re growing your business, you may want to take a smaller salary at first and put more money back into the company.
A good strategy? Set a percentage. Maybe you start with paying yourself 30% of net profits and adjust from there.
Taxes: What You Need to Know
Ah, taxes, the necessary evil of entrepreneurship. When you’re paying yourself, don’t forget about Uncle Sam. Here’s what you need to keep in mind:
- Self-Employment Taxes: If you’re taking an owner’s draw, remember that taxes aren’t automatically withheld. You’ll need to set aside around 25-30% of your income for federal taxes (and more depending on your state).
- Payroll Taxes: If you’re paying yourself a salary, your business needs to withhold payroll taxes (Social Security, Medicare, etc.), just like any other employer.
- Quarterly Estimated Taxes: Not on the payroll? You’ll probably need to make estimated tax payments every quarter to avoid penalties.
A simple way to avoid tax surprises? Open a separate tax savings account and move money into it regularly.
Common Mistakes to Avoid
Nobody’s perfect, but when it comes to paying yourself, some mistakes can cost you big time. Here are a few things to watch out for:
- Paying Yourself Too Much. If you take too much money out and your business hits a slow period, you might struggle to cover expenses.
- Paying Yourself Too Little. On the flip side, if you underpay yourself, you could end up personally struggling, even when your business is thriving.
- Mixing Personal and Business Finances. Swiping your business card for personal expenses (or vice versa) is a bookkeeping nightmare and could get you into legal trouble.
- Forgetting About Taxes. The IRS won’t forget, so make sure you plan ahead and pay what you owe.
The Bottom Line
Paying yourself as a small business owner doesn’t have to be complicated, but it does take some planning. Whether you’re taking a salary or an owner’s draw, the key is to be strategic, ensuring you’re compensated fairly while keeping your business financially stable.
So, what’s your next step? Review your business structure, set up a system that works for you, and start paying yourself like the boss you are!