How to pay yourself as a business owner: it’s one of those things you need to figure out early on in your business’s lifecycle.
Obviously, you need money to pay your rent or mortgage and cover all your other living expenses. But it’s important to keep the needs of your business in mind as you set about determining how to pay yourself, and how much to pay yourself.
It’s a careful balance to strike: you want a decent income, but you also want your business to thrive. This guide has an easy-to-understand breakdown of the major methods, along with a few tips.
There are three ways to pay yourself as a business owner
Business owners can pay themselves via salary method, owner’s draw, or a combination of the two.
Each has its pros and cons, and we’ll cover what those are in this article so you can make a better decision about which to choose for yourself.
The salary method is reliable
With the salary method, you pay yourself a set amount each pay period with a paycheck that has taxes withheld. It’s the same method you use to pay employees.
Don’t expect to pay yourself an inflated salary. The IRS has something called a “reasonable” compensation requirement, which means your salary should be the value that would ordinarily paid to someone doing the same job in your industry.¹
Owner’s draws offer flexibility
If you want to take money as needed, you can use the owner’s draw method. You draw profits from the owner’s equity, which is the share of a company’s net assets that you own.
There is one challenge with this practice, and that’s taxes. You don’t have to pay taxes when you draw, but you do need to budget for estimated tax payments and further tax payments at the end of the year. Business owners who don’t budget properly can find themselves in a tough spot come tax season.
Using a combination of salary and owner’s draw
If you want to pay yourself a salary and draw from your equity, you can. Depending on your situation, this could be the most tax-advantageous method. But it will be complicated, so you’ll want to work with a CPA.
Your choice of payment depends on your business structure
If you have an S-corporation, C-corporation, or limited liability company taxed as a corporation, you’re required to take a salary, though you do have the option of drawing money, too.
If you’re a sole proprietor or in a general partnership, you’ll most likely pay yourself a draw. If you do draw, remember to save enough for your taxes.
Watch out for common pitfalls when paying yourself
It can be easy to make a mistake during the process. Watch out for these common issues.
Separate business and personal finances
Keep your business finances separate from your personal finances. Set up a separate business bank account and ensure all transactions occur on it. You’ll have an easier time tracking your business’s financial health and avoid issues with the IRS.
Keep your compensation reasonable
I mentioned earlier that this is a requirement of the IRS, but many business owners still neglect to pay themselves a reasonable amount. Consider your industry’s standards, your experience, and the financial health of your business.
Having a structured salary will also show investors that your business is financially stable. And regularly review your finances to make adjustments.
Keep in mind cash flow and seasonal business changes
Seasonal or economic shifts can affect your business, which in turn increases or decreases cash flow. Whether you’re setting a salary or drawing from equity, keep fluctuations in mind so you don’t find yourself in the red. And if you do have extra funds, reinvest them in the business.
Give me a call for further consultation
I’ve been advising businesses on tax, accounting, and finance for over fifteen years. If you’re in the Fort Worth area and need help setting up a salary amount, determining the correct draw, or need help with another accounting issue, I can help.
Schedule a discovery call today.
Jeremy A. Johnson, CPA
- Exempt Organization Annual Reporting Requirements: Meaning of “Reasonable” compensation [Internet]. Irs.gov. [cited 2023 Oct 22]. Available from: https://www.irs.gov/charities-non-profits/exempt-organization-annual-reporting-requirements-meaning-of-reasonable-compensation