How should I pay myself as an owner?

How should I pay myself?

When you work as an employee, things are simple; receive a paycheck and file your taxes at the end of the year. When you own a business, compensation becomes more complicated. How should you pay yourself as an owner? Let’s discuss four important questions to help you decide.  

What is your business type?

Depending on the type of entity of the business, there may be special rules regarding owner’s pay. Why is the business type so important? 

If you own a sole proprietorship, a sole-member LLC, or a partnership, you can pay yourself by means of a “draw” or direct payments from the business to yourself. If you own an S-Corp, the rules are slightly different. You can receive draws by way of distributions, but you must also pay yourself a reasonable salary.

Since every business is different, it would be helpful to consult with your accountant or tax professional to understand your business type and the rules that apply to you with regard to owner’s pay.

How much should I pay myself?

How much is enough? The amount can vary from person to person. Here are some suggestions that can help.

Review your profit and loss statement. Carefully review the amount of net profit your business is making. Net profit is calculated by taking gross revenue less all business expenses. Some business owners use a percentage method based on net profit to determine how much they should pay themselves. Others use a fixed amount and adjust it based on the growth of the business. In either case, the amount of owner’s draws or distributions should not exceed the business’ net profit. 

Establish a reasonable salary for yourself. If you own a business type where an owner’s salary is required, you want to make sure your salary is reasonable. A good way to determine this amount is to ask yourself: “If I hired someone to do what I do, how much would that individual be paid?” Sometimes we see business owners purposely paying themselves a really low salary. Not only can this raise a red flag with the IRS, but you can lose out on some tax benefits associated with payroll. 

Examine your personal budget. For you and your family, how much compensation do you need to provide for your needs? If you aren’t sure, create a monthly budget of your current income and expenses. Be sure your budget not only includes day-to-day costs but includes any goals you have to save for retirement, education, or taxes. 

How often should I pay myself?

Paying yourself only when you think there is enough money in the bank creates stress and uncertainty. Therefore, we encourage business owners to schedule their compensation at regular intervals.

If you are paying yourself with a salary, try to use the same payroll schedule as the rest of your employees. If you are receiving owner’s draws or distributions, set up a consistent schedule to transfer funds to your personal account. Many business owners schedule draws on a monthly or quarterly basis depending on their needs. 

How will this affect my personal taxes?

When it comes to paying yourself, it’s important to understand how your compensation will impact your personal taxes. Why do we say that?

If you are taking owner’s draws or distributions from your business, taxes are not deducted when you receive the funds. This means that there may be taxes due when you file your individual tax return. If you are required to take a salary, carefully review your tax exemptions to make sure you are withholding a sufficient amount of payroll tax. 

One additional tip we share with business owners is to use some of their owner’s pay to save for taxes. Since tax rules often change, having an amount set aside for taxes can reduce a lot of the stress and unknowns that come with tax season. 

By considering a few important questions, business owners can ensure they are compensated fairly while maintaining a profitable business. What if your struggle is wondering what happened to your profit? Check out another one of our articles discussing profit here.