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How to pay yourself as a business owner depends on the business structure, the stage of growth of your business and other factors.
While paying yourself may not be the first thing that comes to mind as you’re building a business, knowing the factors to consider and using the correct payment method can set you up for success as the business grows.
Ways to pay yourself: Salary vs. owner’s draw
There are two main ways to pay yourself as a business owner:
Salary: You pay yourself a regular salary just as you would an employee of the company, withholding taxes from your paycheck. This is legally required for businesses that are structured as S-corporations or C-corporations or a limited liability company taxed as a corporation. The IRS has a “reasonable” compensation requirement, which means your salary should be comparable with what someone else doing the same job in your industry would be paid.
Owner’s draw: You draw money (in cash or in kind) from the profits of your business on an as-needed basis. You can draw up to the amount you put into the company, which is known as owner’s equity. You don’t have to pay taxes upfront every time you take a draw but it’s wise to set aside money regularly to budget for your tax bill.
Here’s a comparison of both methods:
There are other methods of taking money from your business, such as dividends and distributions. Whether and how you can use these methods depends on the structure of your business. An accountant can advise you on the pros and cons of each.
How to decide
These factors determine how you pay yourself.
Your specific business structure, whether it's a sole proprietorship, a partnership, LLC, an S-corp or a C-corp, dictates whether you can take a salary and/or an owner’s draw. Typically, you can take an owner’s draw if you have a sole proprietorship, partnership or an LLC, and you can take a salary when your business is a corporation or an LLC taxed as a corporation. An accountant can walk you through the requirements and tax advantages of your business structure.
Many entrepreneurs don't take any money in the early stages of their business. But as soon as your business is on firmer footing or you have a good sense of cash flow, start thinking about paying yourself so that you can factor that amount into the business's operating expenses.
The payment amount and method you use should cover all your personal obligations, such as a mortgage, car loan and basic expenses. If your finances aren’t strong or you aren’t paying yourself at all, that may put you at a disadvantage when seeking small-business financing.
How much should you pay yourself?
Once you’ve decided how to pay yourself, you need to pick an amount. The average entrepreneur makes about $68,000 a year, based on self-reported salaries at Payscale, a compensation software company.
If you’re taking an owner’s draw, your pay should come from the business's net profit, which is revenue minus all operational expenses. That ensures you meet all business obligations (including paying employees, if you have them) before paying yourself. One rule of thumb is to pay yourself a fixed percentage of the business's profit so that your compensation can adjust according to the performance of your business.
Mistakes to avoid while paying yourself
Mixing personal and business finances
This is a basic tenet of business: Always keep your personal and business accounts separate. Using a business credit card to pay for your personal expenses or not actually transferring your pay or owner’s draw from your business account to a personal account can lead to accounting complications and hurt your chances of getting a small-business loan.
Not budgeting for taxes
If you are using the owner’s draw method, you should keep a part of every draw aside for taxes since they aren't deducted upfront. As a business owner, you also have to pay taxes on a quarterly basis; accounting software can typically help with that. If you don’t budget for it, you risk being hit with a big tax bill, and you may not have the cash on hand to pay.
Never paying yourself or being inconsistent about it
You may not pay yourself in the beginning, but ideally, your compensation should be part of your business plan. Your financial projections should include the amount of your salary or owner’s draw to help you understand what your business needs to grow.