Business owners have several options on the table when it comes to getting paid. The most advantageous choice will depend on business structure, profit, and tax situation. If you’re wondering how to pay yourself as a business owner, here’s a breakdown of what you need to consider first.
How do business owners pay themselves?
Payment methods for business owners will depend on the company’s structure. Sole proprietors can use an owner’s draw, while partnership owners have a choice between distribution and guaranteed payments. If you structure your business as an S or C corporation, you can choose between distribution payments or a traditional salary. What all these methods have in common is that your payments will be taken as a cut of business profit.
How to pay yourself as a sole proprietor
How do business owners pay themselves when they are sole proprietors? A sole proprietorship means that your business isn’t legally separated from your personal finance as it would be with an S or C corporation. Because there’s no distinction between business and owner, it means that all business profit is considered by the IRS to be personal income. When figuring out how to pay yourself as a sole proprietor, this tax distinction is something to keep at the forefront of your strategy.
Sole proprietors can withdraw earnings from their business to pay themselves a wage, called an “owner’s draw.” These draws must be recorded on the balance sheet under the owner’s equity section, listed as negative accounting entries.
How to pay yourself: LLC partnership
What happens when your business is structured as an LLC partnership? LLC partners can also withdraw their earnings in the form of draws, which works the same way mentioned above. The only difference is that each partner must pay a percentage of total income tax, determined by the percentage of partnership or ownership.
For example, imagine that there are two partners who will be taxed together on the business’s full profits. If both own 50% of the business and the partnership has taken in $200,000 in profit over the past tax year, each partner will be liable for the taxes on $100,000.
Another way in which LLC partnerships differ from sole proprietorships is that LLC partners have the option of taking guaranteed payments. These are taken out of the profits as guaranteed income and should therefore be recorded on the profit and loss statement. For example, imagine that Partner 1 takes a payment of $30 per hour for $1,000 hours each year. This means they would take $30,000 as guaranteed payments. The $30,000 is also taken out of the company’s net income, appearing on the profit and loss statement as a guaranteed payment.
How to pay yourself: LLC as an S or C corporation
Payment options are different when your LLC is structured as a corporation because this means your business is a separate entity. LLC shareholders can’t be paid in draws, but instead can be paid a salary as well as dividends. Income tax and payroll tax should automatically be withheld from the owner’s salary, just as it would with any other employee. One thing to keep in mind is that the IRS states that S corporation shareholders should be paid “reasonable compensation,” meaning the salaries should be proportionate to what an employee would expect to receive.
What percentage should you pay yourself from your business?
So, what is considered reasonable when it comes to an owner’s salary? In other words, what percentage should you pay yourself from your business? There’s a need to strike the balance between retaining profits for reinvestment in the business, managing tax liabilities, and taking out enough to comfortably live on.
It’s helpful to first create a budget by adding together your annual personal expenses. You should pay yourself this total as a minimum. You’ll also want to sit down with an accountant to figure out tax liability to be sure you’re maximizing credits.
Finally, remember that no matter which method you choose to pay yourself, you must keep detailed records. All withdrawals and salaries need to show up on your financial statements for auditing purposes.
We can help
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