Congratulations! You’ve started (or are thinking about starting) your own business! You’re ready to be your own boss, set your own hours, develop your own brand, but have you given any thought to how you’ll pay yourself? It’s not as simple as saying “I’ll just take what I need, when I need it.” Well it could be, if you don’t want your business to succeed which I’m guessing is not the case. Paying yourself as a business owner depends on the business structure, the stage of growth of your business and other factors. No need to panic, I’ll walk you through it all in this post.
Before I jump into the different payment types, I want to stress the importance of separating your business and personal finances. Commingling funds is a disaster waiting to happen. Even if you can't get a "business bank account" or "business credit card", you can still designate a personal account or credit card for business use only. It makes it much easier to determine what expenses during the year were related to your business.
HOW DO I PAY MYSELF?
If you’re a sole proprietor, single-member LLC, or a partner in a partnership or multi-member LLC, and have not elected S-Corporation (S-Corp) taxation, you cannot be on payroll. Instead you’ll pay your via owner’s draw (also called member’s draw or member’s distribution for partnerships). What is owner’s draw exactly? It’s when you draw money (in cash or in kind) from the profits of your business on an as-needed basis. You don’t have to pay taxes upfront every time you take a draw (becuase you’ll pay tax on the net income of the business, regardless of how much or how little you withdraw).
If you elect to be taxed as an S-Corp, you’d need to be paid a reasonable salary (via payroll) since you’d be considered an employee, before you could take any distributions from the business. The concept of reasonable compensation is about as clear as mud, but essentially, it means your salary should be comparable with what someone else doing the same job in your industry would be paid. We strongly suggest completing annual S-Corporatireasonableon compensation studies to substantiate your compensation in the event of an audit.
HOW MUCH DO I PAY MYSELF?
Deciding on the amount you pay yourself is an important decision. Some business owners look online for the average salary for their type of business and job performed. If you don’t want to commit to an exact dollar amount, you can opt to take a percentage of the profits the business is making. This allows for growth and loss fluctuations.
Not sure which is right for you? ASE Group can help. Reach out for a consultation or to complete a comprehensive reasonable compensation study!