If you run a business, one of the most important things you have to learn is how to pay yourself as a business owner. There are two main ways to do this: salary or an owner’s draw. Both options have pros and cons.
In this blog post, we’ll discuss the differences between salary and an owner’s draw, and help you decide which option is best for you.
Key Points
- Importance of Paying Yourself as a Business Owner
- How to Pay Yourself as a Business Owner
- How Do You Know It’s the Right Time to Pay Yourself from an LLC?
- How to Compute Salary When Paying Yourself from LLC
- Takeaway: How Do You Pay Yourself from an LLC or a Company?
Importance of Paying Yourself as a Business Owner
The salary business owners set for themselves will have significant implications for the business. If they underpay themselves, they may find it difficult to cover expenses and may even be putting their personal finances at risk. Entrepreneurs pay themselves through owners’ draw and monitor incomes through QuickBooks or similar accounting services.
On the other hand, if owners overpay themselves, they may pay more taxes than necessary. In addition, the owner’s salary can also affect their ability to secure financing from banks or investors.
As such, it’s essential for business owners to consider how much they should pay themselves. By considering certain factors, owners can ensure that they make the best possible decision for their business.
How to Pay Yourself as a Business Owner
Sixteen million Americans identify as self-employed, but how do they pay themselves? As a business owner, you can pay yourself in one of two ways: an owner’s draw or salary. Depending on your business structure, there may be benefits to choosing one over the other.
CEO vs. Owner: Salary or Owner’s Draw
An owner’s draw is when you take money out of your business for personal use and is not considered taxable income. This can be done at any time and any amount, which gives you a lot of flexibility. However, it can also create cash flow problems if not managed carefully.
On the other hand, a salary is an income you earn from working in your business. It’s a set amount that you pay yourself regularly, typically biweekly or monthly.
Owner’s Draw
An owner’s draw is when an owner of a limited liability company, sole proprietorship, or partnership takes money from their business for personal use. Paying yourself from an LLC or sole proprietorship has pros and cons.
Pros:
- It allows you to take out money without incurring personal income tax.
- It helps create a distinction between your personal and business finances.
- It offers you the flexibility to adjust your salary based on the needs of the business.
- It’s easy to draw money in case of financial emergencies.
Cons:
- Drawing money from a business can make it difficult to track business expenses.
- Taking an owner’s draw can also impact your business’s tax liability.
- The money you take out of your business as an owner’s draw is considered personal income and will be subject to personal income taxes.
- Taking regular owner’s draws can also hamper your ability to build equity in your business.
It might be easy to draw money for a sole proprietorship business, but it’s not without consequences. On the one hand, you want to reinvest profits in the business to fuel growth. On the other hand, you also need to care for yourself and your family.
Salary
The wages business owners pay themselves for work done is called the owner’s salary. When weighing the income of the owner vs. CEO, the only difference is how they pay themselves.
While single proprietors take advantage of how easy it is to draw money, business owners of S corporation or C corporation enjoy the stability of regular income through salary.
Pros:
- It can help separate your business and personal finances, which can be helpful come tax time.
- It can allow you to save for retirement in a tax-advantaged way.
- It can protect you from creditors if your business is sued.
Cons:
- It can be challenging to determine how much to pay yourself without running afoul of the IRS.
- It can result in a higher tax bill for the company since payroll taxes will be owed on the salary amount.
- It can limit the amount of money to reinvest in the business, impacting its growth potential.
How Do You Know It’s the Right Time to Pay Yourself from an LLC?
As a business owner, you may be tempted to reinvest your profits in the company to fuel growth. While this can be a wise strategy in some cases, there may come the point where it makes more sense to start paying yourself a salary.
The question of when to start paying yourself from your LLC is often complex, and there are a few factors to consider. Here are three things to remember and serve as a guide:
- You must ensure that your business generates enough revenue to cover your personal expenses. If you’re just scraping by, it may not be the right time to start paying yourself a salary.
- You need to have enough money set aside to cover any unexpected costs or slow periods. It can be helpful to have at least six months of living expenses saved up before starting to draw a salary.
- You should consider whether or not you are comfortable paying yourself from your LLC. In some cases, it may make more sense to leave all of the profits in the company to fund growth.
Ultimately, there is no hard and fast rule for when to start paying yourself as a business owner. It’s important to weigh all factors and decide what is right for you and your business.
How to Calculate Your Salary When Paying Yourself from an LLC or a Company
There are a few things that you will need to take into account when doing this, such as the size of your business, the number of employees, and your overall profit margin. Here are a couple of things to consider when calculating your salary.
- Use personal expenses to gauge how to pay yourself from LLC or a company.
As a business owner, it’s important to be mindful of how much you spend on personal expenses. This can be a helpful gauge for determining your salary. After all, you want to be compensated fairly for your work and the profit you generate.
If you’re not sure where to begin, try estimating the cost of your basic living expenses and adding a reasonable profit margin.
- Hinge the amount you’re paying yourself on the profit of your LLC or company.
One way to determine your salary is to base it on profit. This means that you will only receive a paycheck if the company makes money. This arrangement can incentivize you to make intelligent decisions and keep costs low. It can also motivate you to grow the business since you will only see a direct benefit from doing so.
Profit-sharing arrangements are not without risks. If the company goes through a rough patch, you may find yourself without a steady income. However, if you’re confident in your business’s prospects, basing your salary on profit can be a great way to ensure that you are compensated fairly for your work.
Takeaway: How Do You Pay Yourself From an LLC or a Company?
As a business owner, it’s important to understand how to compute your salary. You’ll also need to find the balance between what you’re worth and what you can afford to pay yourself. After all, you want to be able to cover your personal expenses and still have money left over to reinvest in your business.
Frequently Asked Questions
Can I pay myself from my business?
As a business owner, you may be wondering if you can pay yourself from your business. The answer is yes, but you need to figure out how to pay yourself depending on whether your business is an LLC or a corporation.
How much should I pay myself as a business owner?
Calculate how much money your business will need to cover its expenses. This includes things like rent, utilities, wages, and taxes. Once you have a realistic estimate of your business’s expenses, you can consider how much you should pay yourself. As a general rule, business owners shouldn’t take home more than 50% of the company’s profits.
When should business owners pay themselves?
As a business owner, it can be tempting to pay yourself first and foremost, but that isn’t always the smartest move financially. You should wait to withdraw money from your business until it generates enough revenue to cover your salaries and other expenses. This gives you a cushion in lean times and ensures your business can sustain itself.
How do business owners pay themselves?
If you have a business, you might be uncertain about how to pay yourself as a business owner. The answer depends on the business type and its financial situation. Some business owners take a salary, while others take a draw from profits.