As soon as your business starts making money, you must decide how to pay yourself. Paying yourself isn’t complicated, but there are tax considerations to be aware of.
There are two main ways to pay yourself as a business owner: by taking a salary or by taking an owner’s draw — or a combination of the two.
Here’s a detailed description of both options and other factors you must consider.
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Take an Owner’s Draw
When your business has a profit, you can take that profit as income. You can simply write yourself a check from the business and deposit it into your personal account; this is called an owner’s draw.
If you pay yourself this way, all of your income will be considered salary and will be subject to self-employment taxes — which is the employer portion of Social Security and Medicare.
| Owner’s Draw Pros | Owner’s Draw Cons |
|---|---|
| Simple, no need for a payroll service | Inconsistent income |
| Flexibility based on business profits | You’ll need to budget for taxes |
Pay Yourself a Salary
A salary is a fixed payment made by an employer to an employee. While most salaried employees are paid bi-weekly, salaries are often expressed as an annual amount.
As a business owner paying yourself via salary, you would give yourself a regularly scheduled paycheck in a predetermined dollar amount. When you pay yourself a salary, your paycheck would have taxes (including FICA or self-employment tax) taken out before you receive it.
It’s important to note that if you choose to pay yourself a salary, you are bound by the IRS’s “reasonable compensation” rule. It states that your salary must reasonably align with what you’d earn for the same job at a corporation or other business.
This matters if you are taking distributions along with your salary. The government wants it’s the Social Security and Medicare taxes it’s due for that job. So don’t pay yourself too little.
| Salary Pros | Salary Cons |
|---|---|
| Consistent income makes it easier to create your personal budget | You have to have a payroll service |
| Saves money on self employment taxes | Must be an S-corp |
Paying Yourself Based on Your Business Type
Deciding whether to pay yourself a salary or an owner’s draw may depend on the type of business you own, with personal decisions and IRS requirements at play. Here’s a closer look at some different scenarios related to drawing income from a business.
Sole Proprietorship
A sole proprietorship is an unincorporated business owned by one person. As a sole proprietor, you and your business are one entity. What the business earns, you earn.
As a sole proprietor, you’ll typically pay yourself a draw. But while you don’t have to share the profits with another business owner, you are fully responsible for covering any business expenses and liabilities.
Because of this, you’ll want to ensure you set aside a percentage of your business’s profit for taxes.
LLC
An LLC (Limited Liability Company) is a legal structure designed to separate a business’s liability from its owners. Your business is now a separate entity for legal purposes, but it’s considered a pass-through entity for tax purposes. You can designate your business as an LLC whether you are a single owner or you have business partners.
So, as far as paying yourself is concerned, it works the same as being a sole proprietorship.
Regarding tax filing, single-member LLCs are taxed like sole proprietors, while multi-member LLCs are taxed as partnerships.
Partnership
Partnerships work a bit differently when it comes to paying owners. You can’t take a salary when you’re a member of a business partnership. You’ll be taxed on your percentage of the business profits. Therefore, a draw or similar distribution of profits is required.
However, if you perform services outside of your capacity as a partner, you can be paid as an independent contractor for those services.
Corporation
A corporation is a business legal structure that taxes the owners, or shareholders, separately from the entity. There are C-corps and S-corps. S-corps are for small businesses.
The IRS assigns S-corps a special status, giving them tax advantages over C-corps. As the owner of an S-corp, you will get paid via a salary as well as earning distributions on profits as a shareholder.
If there are other shareholders in your S-corp, they’ll also earn distributions.
Your salary is taxed as wages, on which you will pay income taxes and Social Security and Medicare. Any distributions you receive will only be subject to income taxes.
Mistakes to Avoid When Paying Yourself As a Business Owner
When planning to draw income from your business, it’s important to avoid errors that could hurt your business or your personal finances. Here are some mistakes to avoid.
Mixing Business and Personal Funds
No matter how small your business or side hustle is, you should open a business checking account to avoid mixing your business and personal finances.
If you don’t, it can be difficult to sort things out come tax time. A low-fee business banking account that offers built-in payroll and other financial tools can help.
Also, if you have an LLC, having separate finances is important to maintain that legal separation between you and your business.
✨Related: Best Banks for Small Businesses
Forgetting to Put Aside Money for Taxes
One of the most common mistakes new business owners make is forgetting to set aside enough money for taxes.
Even if you pay yourself via payroll, you probably have income where taxes were not withheld. You’ll want to ensure you have enough to pay what’s due at tax time. Common advice is to set aside 30% of your income for taxes. But if you aren’t sure, speak to your accountant, and they will be able to advise you.
To make it easy, some business checking accounts allow you to earmark money for taxes. For example, a Bluevine business checking account allows you to set up sub-accounts so you can set money aside for your business’s taxes and future expenses.
✨Related: Estimated Taxes, Due Dates, and Safe Harbor Tax Rules
Not Leaving Enough in the Business
You’ll want to leave enough cash in the business to account for any cash flow needs your business may have.
It can be tempting to write yourself a check for every dollar of profit, but if you don’t leave a slush fund in your business, you may find yourself simply putting that money back in.
You want your business to have enough cash to take advantage of opportunities or cover surprise expenses without affecting your personal finances.
FAQs
While you aren’t required by law to open a business checking account as a sole proprietor, it makes it easier to run your business and file taxes.
There’s no set percentage when it comes to paying yourself as a business owner. However, you can choose a percentage-based pay structure. Just be sure that the percentage you choose takes into account your upcoming tax bills and business expenses.
How you report your business income depends on several factors, but mostly on how your business is structured. For instance, a sole proprietorship’s income is included on the owner’s personal tax return. Conversely, C-corporations file a business tax return. If you’re unsure, consult with an accountant for advice on how to report your business income.
Hiring a tax professional to manage your business’s finances can be a good idea. Whether or not you need to do that depends on a variety of factors, such as how complex your business finances are, your own level of financial expertise, and more. Talk with a tax or financial expert for more information.
Final Thoughts
Knowing how to pay yourself as a business owner is important. There are a variety of factors that come into play as you make payroll and other financial decisions for your business. Start by considering how your business is structured, and go from there. If you need more help, don’t hesitate to speak with an accountant or business advisor who can help you decide how to pay yourself as a business owner.