January 10, 2023
As a business owner, you may have a lot of questions about your own compensation. How should you pay yourself as a business owner? How should you take the money? When should you start paying yourself? How much is too much or too little? We know that running a business is a lot of stress, so we’re going to help you out by answering these questions and giving you some recommendations. It is also highly recommended to find a reputable accountant that can help you with your specific business.
You have a couple of options on how to pay yourself as a business owner, such as, pay yourself a salary or taking an owner’s draw. Let’s look at the pros and cons of each of these options to help you determine which method works better for you. Although, you business entity will determine how you pay yourself as a business owner.
According to IRS requirements, you are required to take a salary to pay yourself if you own an S or C corporation. By doing so, tax withholdings and benefit payments will automatically be deducted and that is one less thing that you will have to worry about later.
If you perform essential functions for an S-Corp, you need to pay yourself a salary that’s comparable to what professionals in similar roles are paid. With an S-Corp, shareholders have tax liability. You can also receive an additional distribution of the company’s profits, which is not subject to withholding but should not be large compared to your salary.
Much like an S-Corp, if you are heavily involved in managing the C-Corp, you’re considered an employee and must pay yourself a salary. You can also pay yourself a distribution, but these are subject to income taxes.
An owner’s draw is when you take money out of the company for your personal use. If you own a sole proprietorship or partnership, you’re considered to be self-employed and will report business profits on your personal tax return.
- Sole proprietorships
A sole proprietor can take their payments from earnings through draws. You will be taxed on the draws that you take.
You can take a distributive share, but you can’t be paid a salary. Your portion of taxes to pay on business profits is determined by your personal agreement with your other partners.
When should you be taking your draws or compensation?
It’s common for small business owners to not take any compensation during the first few years of being in business. It’s during this time that your business either starts to settle into either growth patterns or profits plateau. Don’t wait too long though! Without factoring in your compensation, your books will not be entirely accurate, and you will not be able to make informed business decisions.
Ask yourself these three questions:
- Do I have sustained revenue?
- Do I have steady projected revenue?
- Is my business in the black?
If the answer to all three is YES, then you can afford to start paying yourself.
How much should I take?
When you start a company, you perform most – if not all – of the roles. How much should you be paying yourself as a business owner, for all of these roles? There’s no set formula or clear answer for this. Ultimately, you need to find the happy medium between paying yourself enough to avoid burnout and paying yourself so much that you’re taking away from the business’s growth potential.
In the Beginning
A good way to start is to create a budget for yourself outside of the business. What does it take to pay your bills and maintain your lifestyle? You’ll want to stay on the modest side of that for a while. This number is one that your accountant can help you with as well, since they know your finances inside and out.
Later on, you should review your compensation to make sure your personal cut of profits grows with the company. Are you happy with what you’re making? You are your business’s most essential worker, so your compensation should be treated as a critical part of your retention. Once again, be sure not to overcompensate yourself.