How to Pay Yourself as a Small Business Owner
Janet Schaaf is a freelance writer, editor and proofreader who considers reader advocacy to be her calling. After taking a few roads less traveled, Janet completed a bachelor’s degree in English Literature from the University of Missouri-Kansas City, with English Department Honors. She has been correcting grammar and checking facts since she could string a sentence together. For the past three years, Janet has focused on making personal finance topics understandable and relatable. Loan terms and credit card agreements can look overwhelming, but understanding what you’re agreeing to is paramount in grasping the impact debt can have on your life.
As a small business owner, reaching the stage where you can afford to pay yourself is an exciting milestone. But before you cut that check (or initiate the bank transfer), it’s important to know how to pay yourself as a small business owner.
How you pay yourself depends largely on the structure of your business, its stage and what you need from it. You have two primary options: salary or draw. We’ll cover these in detail below to ensure you can take care of yourself financially while your business grows.
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Salary or draw: two ways business owners pay themselves
As a small business owner, you have two main options for paying yourself: salary or draw.
Salary
A salary is a set amount of money paid for services provided to the business. This payment is usually made on a regular basis, such as weekly, bi-weekly or monthly. It’s usually a set amount but may be based on the number of hours worked or other factors. Salaries can range from minimal to six figures depending on the size of the business.
When you pay yourself a salary, you cut a paycheck and withhold the applicable income and employment taxes from your compensation.
Owner’s draw
An owner’s draw is a way for business owners to pay themselves without issuing a paycheck or withhold employment taxes. You can simply write a check to yourself from the business checking account or transfer money from your business account to your personal account.
You can take a draw regularly each week or month, or just when you need it and the amount you take as a draw can fluctuate.
Here’s how salary vs. owner’s draw compare:
| Salary | Owner’s draw | |
|---|---|---|
| Pros | Provides more stability than an owner's draw since it is paid in regular intervals rather than as profits come in. Can be beneficial for budget planning purposes since the amount is known beforehand. | Allows you to take home your full income without paying taxes first. Money can be taken out when needed rather than in a fixed salary schedule. |
| Cons | Requires withholding and paying employment taxes before determining your take-home salary. Requires additional paperwork for payroll tax reporting purposes. | You may not know how much money you'll be able to take home until profits come in each month. Not as beneficial for budget planning purposes as a salary since the amount is unknown ahead of time. |
Other forms of payment: Shareholder’s distributions or dividendsIn addition to a salary, corporate shareholders can also receive dividends or shareholder distributions. Dividends and distributions are payments made by corporations to shareholders out of profits after taxes have been paid. The company can pay dividends and distributions in cash, in stock or other property.
How to decide how to pay yourself
When deciding how to pay yourself as a business owner, there are several factors to consider.
Business structure
The type of business entity you choose impacts how you pay yourself.
| Business entity | Payment method options | Tax method: payroll or self-employment? | Tax form |
|---|---|---|---|
| Sole proprietorship | Draw | Self-employment | Schedule C (Form 1040) |
| Partnership | Draw | Self-employment | Form 1065 |
| LLC* | Draw | Self-employment | Form 1065 |
| S-corp | Salary and draw | Payroll | Form 1120-S |
| C-corp | Salary and dividends | Payroll | Form 1120 |
*Note: Single-member LLCs are treated like sole proprietorships for tax purposes. LLCs can also elect to be taxed like S-corps or C-corps.
Business stage
For entrepreneurs to pay themselves, the business should be turning a profit. That way, the company won’t struggle to pay its operating expenses and business loans it has. However, this can be difficult for businesses in their early stages, as many startup businesses don’t turn a profit for several years.
As a business owner, it is important to pay yourself as soon as you can. Paying yourself should be considered a regular operating expense — not just something that should happen once the business takes off.
Personal living expenses
When setting the amount of your salary as a business owner, you must consider both the IRS’s “reasonable compensation” expectations and what you need to earn to live. It’s important to consider how your salary will affect other areas of your personal budget, such as housing, retirement and paying your own bills.
Mistakes to avoid when paying yourself as a small business owner
To help you avoid missteps when paying yourself, here are some of the most common mistakes small business owners make and how to avoid them.
Not planning for taxes
It is essential to plan for taxes when paying yourself as a small business owner. When you pay yourself — whether through an owner’s draw, salary, dividends or distributions — you have to consider taxes.
If you pay yourself a salary, you can withhold income and employment taxes from your paycheck. However, if you take an owner’s draw, you may need to make quarterly estimated payments towards income and self-employment taxes. It’s a good idea to work with an accountant or tax professional to figure out how much you should withhold or pay in.
Mixing personal and business finances
Keeping personal and business finances separate is crucial for a business owner. It makes keeping accurate records of your business income and expenses easier and makes it easier to file taxes. Depending on your business structure, it might be required to maintain the legal separation between you and your business.
To keep your business and personal finances separate, open a business checking account and use it only for business expenses. Try to avoid paying personal expenses out of your business account and vice versa.
Not consistently paying yourself
Paying yourself consistently is essential as it allows you to stay on top of your personal finances while running your business. Consider your own salary or draw as a regular operating expense — not just something that happens if and when you make a profit.
Not recording your pay in bookkeeping
Recording your pay in your business bookkeeping system will help you accurately track expenses and available cash in your business checking account. This will help prevent potential financial mistakes or errors in accounting.