Now that you own your own business, you’re rolling in dough. Ha! Don’t we wish it worked like that? But money seems to be a big question for a lot of new business owners, specifically, how do you pay yourself?
It seems an easy enough concept—money comes in and you get to keep that. Well, yes and no. Technically, all that money is yours, but as the owner, you have a lot of other responsibilities to take care of first—bummer—and how you pay yourself is one of them.
The worst thing you can do as a business owner is to NOT pay yourself. I have made this mistake, myself, and I completely understand the reasoning. Some months are tight. Sometimes the government shuts down your business (thanks, Covid). Some business expenses are important enough to sacrifice for, but stiffing the literal boss isn’t the sacrifice you should make. As business owners, we often put our financial needs at the bottom of the list and then wonder why we feel burnt out and under-appreciated. Take yourself and your work seriously. You wouldn’t ask an employee to work for free, so why should you?
Rule #1 in paying yourself is to PAY YOURSELF!
As a business owner, you have many options for compensating yourself properly, but each comes with tax implications and will depend on the type of business structure you decided to make (see my article “10 Steps to Starting a Business”).
Sole-Proprietors & LLCs
Not everyone will recommend treating Sole-Proprietorships and LLCs in the same way, but I disagree. Even though the tax implications on a Sole-Proprietorship are not as intense as with an LLC, you should still treat them similarly in that you want to keep your books clean and separate. Do not cross the streams!
In the eyes of the IRS, there is no legal need for separation as a sole proprietor—your money is classified in the same way—but the purpose of bookkeeping is to show where your personal living expenses differ from your business-related income and expenses. Get separate credit cards and bank accounts and keep a record (even a crappy one).
With a Sole Proprietorship, you can pretty much do a bank-to-bank transfer of money from a business account to a personal account whenever you like, but I strongly advise you keep everything separate.
LLCs and Partnerships
Sole Proprietors, take note! This is how you really should do it!
When you register for an LLC or a partnership, how you pay yourself as an owner becomes a bit more difficult and complicated.
Surprise! You can’t just take money whenever you want. Instead, you will make what is called an “Owner’s Draw,” “Owner’s Distribution,” or “Shareholder’s Loan.” However you and your bookkeeper or accountant want to classify it, that’s how it will be calculated. If you are doing this on your own (whoop whoop), then I highly recommend bookkeeping software.
Basically, you’re paying yourself (as a boss) by writing yourself a check to yourself (as an employee). It sounds a bit confusing, I know, but the idea is to make a distinction in how your business money is spent. You want a clear path of where the money went and why.
You also have the option to pay yourself as an employee with wages, but this becomes more tiresome and expensive if you live in a high-tax state. You should also note that as a salaried employee, you are still entitled to any year-end distributions, but I digress.
A final way to pay yourself is as an independent contractor, doing specific work for the LLC you own. Here’s an example: You are a member of an LLC that owns a spa. You hire yourself as a licensed massage therapist to work on a client. Like any payment method, there are pros and cons, but remember if you choose this method, you will need to (as the owner) file an IRS form 1099 to yourself. Weird.
Owner’s Draw is the simplest and cleanest (and therefore best, in my opinion) way for an LLC owner to pay themselves (and for the over-achieving sole proprietors to pay themselves).
S-Corps and Corporations
I love S-Corps! There are a lot of benefits to having one, but it doesn’t work for every business. If you do choose to create an S-Corp, you are required to have a regular salary. It’s not an Owner’s Draw.
As a corporation, your business will have its own tax return and you must show “reasonable compensation.” If you’re not sure what that equates to, you can use the industry standard, or calculate your specific business’s capabilities. The term “reasonable compensation” is a phrase the government included in tax law to ensure people do not under or over-report their personal income, or under or overpay themselves and there are big penalties for incorrect payroll tax reporting. Gulp!
If you’re trying to figure out what you should be paid, or at least what your company can afford, this is the general format I use:
Profit (or loss) = total revenue – business expenses
Taxes = 30% of profit (or sometimes more if you live in a high-tax state)
Your Paycheck = 70% of profit
This is a baseline equation and should be tweaked to your specific circumstances. For example, I like to pump a little extra into the company for a rainy day (or more taxes), so I might only pay myself 60%. That sounds like a lot, but don’t forget that is 60% of net profits, not gross. So, if you make $500,000 in sales you aren’t making $300,000. You are making $300,000 minus the 3% credit card processing fees, minus the 35% taxes, minus the 50% independent contractor payments, minus the 15% advertising, etc. You get the idea. Taking a realistic view of what you make can definitely help you tackle that budget.
What do I use?
It depends on which business—I own a few and pay myself differently with each. I once owned an S-Corp under which I paid myself as a salaried employee, as an independent contractor receiving a 1099, AND as an owner taking owner’s draws. Intense, right? Confusing? Yup! But it’s what worked for the business I had. And obviously, I highly recommend you chat with a CPA or accountant to figure out what the best option is for you. After nearly 20 years of owning businesses, my preferred method is Owner’s Draw, but again, that depends on the circumstances.
When Do I Pay Myself?
Hooray, you’re the boss! You decide! Normally, people are paid:
- Bi-weekly (every other week)
- Semi-monthly (twice a month)
How you pay yourself (and your employees or contractors) is largely a personal opinion. Sometimes I would pay on the 1st and 15th. Sometimes every other Friday. Sometimes every Friday. Mostly I based it on how much administrative work it required and whether or not I could afford to pay someone to do it, or had the time to do it myself.
What’s the BEST Way to Pay Yourself?
There is so much more than a simple formula when calculating how and what to pay yourself as a business owner, but the great news is that it’s also completely customizable to you and your specific business needs. You can customize your business plan (you have one, right?) to accommodate any number of scenarios. And if it just isn’t working, you can change it again and again until your system suits you. Just always remember Rule #1!
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