As a small business owner, you put in a lot of effort to ensure your company prospers. However, you also deserve to be fairly compensated for your hard work. It’s important to discuss how you can pay yourself and why consulting with an accountant and utilizing a paycheck calculator can assist you in determining your net earnings.
For payments and future goals, your small business needs money in the bank. Additionally, as the business’s owner, you desire to earn a good living or, at the very least, enough money to support yourself financially. Paying yourself can occasionally seem like a struggle between your priorities and the demands of the company.
Payroll Salary Vs. Owner’s Draw
When determining your take-home pay as a small business owner, you generally have two options: an owner’s draw or a payroll salary. Let’s take a look at the differences between these two choices.
Payroll salary
With a payroll salary, you determine a set wage and then give yourself a paycheck every pay period. When choosing a salary, taxes are deducted from your paychecks, and you’ll send your tax payments to the IRS, just like any other employee. Opting for a salary makes it easy to anticipate your organization’s cash needs and helps you pay your taxes on time.
The one downside of this method is that adjusting your salary to meet the IRS criteria for reasonable compensation that align with your job duties, education, skills, and experience can be difficult. If your compensation exceeds the reasonable range, you could trigger red flags with the IRS.
Owner’s draw
An owner’s draw is when you take funds from your business for personal use. You can set up draws at regular intervals or any time when needed. Draws are discretionary, meaning you can take out more or fewer funds based on your business’s performance.
However, unlike a payroll salary, taxes are not withheld and sent to the IRS with this method. This means you’ll have to monitor that cash flow and make quarterly payments or settle your taxes at the end of the year. Additionally, an owner’s draw could lower the equity of your business, lowering the amount of money available for future business expenses.
How to Pay Yourself as a Small Business Owner?
Your business entity type can play a significant role in how you can pay yourself because different business structures have particular rules for a business owner’s compensation. Here’s a closer look at what you need to consider.
Sole proprietorship
A sole proprietorship is a business structure in which there’s no separation between the owner and the business. This means you assume personal responsibility for any business debts.
If your business is a sole proprietorship, you legally cannot pay yourself in the form of a salary. The reason is that paying yourself a salary isn’t a deductible expense when you’re a sole proprietor. Therefore, you must take funds from your business as an owner’s draw. Then, the IRS taxes the overall profit of your business — no matter how much money you draw — and you must file it on your income tax return.
Partnership
A company with two or more owners is called a partnership. You receive money based on your company share and any previous partnership agreements. Like a sole proprietorship, you and your partners are responsible for financial losses from the business.
Partnerships also cannot legally accept compensation via a salary because the IRS doesn’t classify partners as employees. As a result, you can use the draw method and split the business revenue between your partners, or you can get guaranteed payments for services rendered. Guaranteed payments are separate from your profit share, meaning you must pay income taxes and file them on your personal tax return.
Limited liability company (LLC)
An LLC is a business structure where the owner’s liability is separate from the business. No individual is personally liable for the business’s debts or lawsuits. The company would be responsible in these instances.
Whether running a business alone or with partners, you typically need to use the draw method for an LLC. In the eyes of the IRS, LLCs are seen as either sole proprietorships or partnerships. Single-member LLCs are paid and taxed like sole proprietors, while multi-member LLCs are paid and taxed like a partnership.
S corporation
An S corporation is an incorporated entity that doesn’t pay dividends — a distribution of the company’s profits — to the owners — or shareholders. You only pay taxes on your share of ownership, which you claim on your personal tax return. Like LLCs, the company is liable for debts and legal obligations, not the shareholders.
If your business is an S corporation, you can pay yourself via salary and non-taxable distributions. However, you can’t forgo a salary for distributions. You also need to have enough equity in your business to take distributions.
C corporation
A C corporation is an incorporated entity where the business pays taxes on the profits it makes, and the shareholders are taxed on the dividends they receive. Like an LLC and S corporation, a corporation is separate from its shareholders, so it takes responsibility for business debts and legal obligations.
In a C corporation, you pay yourself a salary. You can also receive dividends but remember that these are taxable.
How Much Should You Pay Yourself?
If your business is a sole proprietorship, partnership, or LLC, you can utilize an owner’s draw and pay yourself as you see fit. However, you need to strike a balance that lets you live comfortably and doesn’t affect your business. If your business is a corporation, you must pay yourself a salary that meets the IRS criteria for reasonable compensation. Get familiar with these guidelines and compare the salaries of business owners in the same industry to help determine reasonable compensation.
To ensure you earn a sustainable income and your business flourishes, consulting with an accountant is advisable whether you’re paying yourself a salary or through an owner’s draw. With their expertise, they can assist you in calculating expenses and assessing projected income, helping you establish a reasonable wage while monitoring your business’s progress.
Whether it’s a salary or the owner’s draw, talking to an accountant is a good idea. They can help you calculate expenses and look at project income, allowing you to earn a livable wage and watch your business grow.
You may also want to use a paycheck calculator. Many online services offer this feature to help you easily estimate your take-home pay in your state, no matter if it’s Texas, Ohio, or Florida.
