How to Pay Yourself as a Small Business Owner
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Small business owners want to keep all their business finances in the business to help the business succeed, but they still must pay themselves to cover personal expenses, like mortgages, bills and groceries. Learning how to pay yourself as a small business owner should happen early in the business. Salaries or owners’ draws are the two most common payment options for small business owners.
Small business owners often hate to take money from their operations. Katrina Kibben, the founder and CEO of Three Ears Media, says, “After almost four years in business, I think my business might actually survive. Like, I know it will but somewhere in my gut I always had these doubts.” Small business owners fear that they will run out of money (or opportunities) to help their businesses survive.
However, even small business owners need an income. They must determine how to pay themselves from their business to cover personal costs, like paying off a car loan or buying groceries. Figuring out how to pay yourself as a small business owner is crucial yet complicated.
Let’s look at small business owners' options and how they can choose a suitable payment method.
Salary vs. Owner's Draw?
Small business owners choose to pay themselves with a salary or an owner’s draw (also known as a “draw”).
A salary is a set wage that the owner claims. With a salary, owners would receive a paycheck each pay period. This is the general method owners use to pay their employees.
An owner’s draw is when a small business owner takes business funds to apply them toward personal use. Draws might happen on a schedule or an “as-needed” basis.?
If a small business owner takes an owner’s draw, this amount must not exceed their owner’s equity. Owner’s equity is how much ownership you have in the company. Accountants will say this is the value of what the owner invests in the business after liabilities.
How to Decide on the Right Payment Option
These factors will influence your payment options as a small business owner:
Business structure is arguably the most crucial factor impacting how owners take their pay. The main reason is that the structure of the business influences tax payments.
However, the owner’s financial situation and expenses may cause them to need a higher or lower payment from the business. Additionally, earlier-stage operations tend to produce less revenue, which means later-stage businesses offer more opportunities for owner pay.
Business Structure
Your business structure impacts your available options when it comes time to pay yourself as a small business owner. The entire payroll process should use the business structure as a foundation to ensure accounts are accurate.
Common business structures for small businesses are:
You should take an owner's draw if you have a sole proprietorship, LLC or partnership. A salary is more appropriate if you have a corporation (or an LLC taxed like a corporation).
It may help to start working with an accountant to ensure you meet the requirements for your payment type and take advantage of tax advantages with your business structure.
Personal Financial Status
Ensure the amount chosen for payment covers all expenses in the owner’s personal life. Create a budget that determines how much income is needed and find the most appropriate option.?
If you’re not paying yourself or lack organized finances, it may create a problem later if you seek financing.
Early or Late-Stage Business
It is a good idea to start paying yourself as a small business owner as soon as there is steady cash flow coming into the business. Once a business has a book profit, owners should feel comfortable giving themselves an owner’s draw or salary.?
Evaluating company finances regularly as the business grows past the early stages is a good idea. You will want to adjust your salary or owner’s draw amount to keep the operation in good financial standing.
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How Much Should You Pay Yourself??
Unfortunately, there is no formula for how much money business owners should pay themselves.?
According to PayScale, an average small business owner in the U.S. makes around $61,000 per year. However, depending on the business’s revenue, the owner's experience and many other factors, a fair payment might be much higher or lower.
Small business owners should be able to narrow an appropriate payment amount by considering the payment type that suits the business’s needs and tax status.?
Working with a tax professional is critical for a growing business. These experts will help you:
Building a business that financially supports you takes time and energy but creating a solid foundation with the correct information is vital.
Common Mistakes to Avoid While Paying Yourself
Figuring out how to pay yourself as a small business owner becomes confusing without a solid plan.
Avoid the following habitual mistakes that small business owners make:
Not Including Your Compensation as Part of the Business Plan
When considering how to pay yourself as a small business owner, you might think that owners shouldn’t take any money for a while to keep the operation financially afloat. This is true, but it doesn’t mean you shouldn’t receive payment once your business makes steady money.
A business owner’s compensation should be part of the business plan. Payments should happen consistently, and any financial projects must include all salary or owner’s draw amounts to understand your business’s financial status.?
Mixing Personal and Business Accounts
Most business owners know that combining personal and business bank accounts is not a good idea. Still, this may not seem necessary for new small business owners initially.
Accounting confusion, tax issues and various complications arise when business owners accidentally use money meant for the business on personal matters (or vice versa). Having two separate accounts ensures that dollar amounts are correct and that money is available as needed for business expenses.?
Not Considering Taxes
When using the owner’s draw method, remember that you’ll have to pay taxes on that money later. You don’t deduct taxes before taking the money, so setting aside a percentage of it to pay as part of your quarterly taxes is essential.?
Without budgeting for taxes, you may not have enough money to cover the required amount, which can lead to penalties.
Additionally, C corporations have double taxation. These businesses will have a tax return and pay taxes on net income. S corporations, partnerships and LLCs are pass-through entities. These all have special taxation rules that the IRS requires, so knowing the differences in taxation is crucial for a small business owner.
Top Takeaways?
How to pay yourself as a small business owner
(Reporting by NPD)