Running a business can quickly get in the way of paying yourself appropriately. Here’s how different business structures handle payments to owners, plus tips for including yourself while managing the budget.
- A salary is a regular payment an employee receives, and an owner’s draw is a withdrawal of business funds that can be more sporadic
- Each business structure has its own implications for paying taxes and paying yourself, and sometimes it depends on the business’s shareholder agreements
- Tips for paying yourself:
- Include yourself in the budget
- Think about what you really need
- Assess your worth
- Keep tabs on business performance
- Factor in benefits
Entrepreneurs know that it’s too easy to forego their pay just to keep a business afloat. But most of us can’t afford to work for free or at a significant discount, at least not for long. It’s essential to know how to pay yourself while still effectively managing a business budget.
You can implement strategies to start paying yourself a living wage as an owner while still focusing on boosting the business’s bottom line. Here’s some essential info about paying yourself smartly and tips for getting started.
Salary versus owner’s draw
First, some clarifications: A true salary is when you get a set paycheck each pay period, as you would if you were a regular employee. The nice thing about a salary is that you don’t have to worry about taking taxes out since they’re withdrawn automatically from each paycheck. And you know you can count on a set amount of money every pay period. However, not all business types allow owners to take a typical salary.
An “owner’s draw” is when an owner withdraws funds from the business to use strictly for personal costs. These can be set up to be taken on an as-needed basis or regularly. The benefit of an owner’s draw is that you have more flexibility in what you get paid and can base these payments on how the business is performing.
“Distributive share” is another term to know. These are any owners’ shares of income, whether a credit or gain. These are treated differently when tax time comes around. Sole proprietors and single-member LLCs can withdraw business money, and it isn’t included on their tax returns. But partners, multiple-owner LLC members, and S corporation shareholders record their distributive shares on their tax return on Schedule K.
Note that the way income is distributed in partnerships and LLCs will vary based on the business agreements.
Choosing the right business structure
As touched upon, whether your business is a sole proprietorship, C or S corporation, partnership, or LLC will matter when figuring out how to pay yourself. Let’s walk through what each business structure looks like as far as payment:
- Sole proprietors are not employees and do not technically have the paycheck/salary option. Sole proprietors can draw money from the business to get paid, and no taxes are proactively withheld.
- Partnerships: Partners cannot receive a salary because they cannot be both partners and employees. Partners receive distributive shares from the business and record them on their tax returns. The partnership agreement will govern how profits are distributed.
- LLCs: Members of LLCs also do not take a salary as an employee. Single-member LLCs treat draws like a sole proprietor does, and multiple-member LLCs like a partnership.
- C corporation: Shareholders must take a salary. They may also take dividends if allowed, but sometimes profits are put back into the business instead.
- S corporation: Shareholders must take a salary. Sometimes shareholders have to pay self-employment taxes, but they could take distributions as part of their compensation to avoid these taxes since distributions come from income that was already taxed.
A few other tax considerations: C corporations are doubly taxed, meaning the corporation pays taxes on net profit, and shareholders pay taxes on the income they receive from dividends.
Pass-through entities, which can be sole proprietorships, S corporations, LLCs, or partnerships, pass profits directly to stakeholders, who then report income on their personal tax returns. Pass-through entities do not pay corporate income tax exactly like C corporations usually do.
Tips for managing your business budget and paying yourself
It may just be a temporary reality that you won’t be able to take much from your business until it gets off the ground. You have many expenses to cover, and managing cash flow the right way can make or break the business. Here are a few tips when you’re trying to figure out how to pay yourself:
1. Include yourself in the budget
It’s easy for business owners to pay themselves only when the business is performing well, and what you get paid can vary a lot using this method. You’ll have much more control over your personal income and thus your personal budget if you factor yourself into the budget from the beginning.
2. Think about what you really need
Carefully consider what you really need to get paid right now on a personal level. This is where you should start when including a salary in a business budget. At the very least, pay yourself enough to get by. Outline your basic living expenses each month, including food, housing, bills, and others that are absolutely necessary. Make sure you can pay yourself at least this much.
3. Assess your worth
When determining how much you need to get paid, compare what you got paid at your last job, if applicable, and what you would be getting paid if you worked for someone else doing the same tasks.
4. Keep tabs on business performance
Say you pay yourself a consistent amount each month to cover your basic living expenses. Make sure that if your business starts doing great financially, you also begin to think about paying yourself more. Include this salary in forecasts and consider increasing pay each period, if applicable.
5. Factor in benefits
Just because you’re not a “regular” employee doesn’t mean you don’t need the same benefits. Write down everything required, including health and dental insurance, retirement savings, and anything else that is a must. Make sure these costs are factored into pay when you decide on a number.
Work with tax professionals to create the right plan
Sometimes these details are overwhelming, and you need assistance from the experts. The team at Provident CPA and Business Advisors can assist you with understanding the type of business structure to create, any tax implications, smart growth strategies, and more.
Contact Provident today to learn more about our services.