How to Pay Yourself as a Business Owner (Plus, Avoid These 3 Mistakes!)
When you take the leap from employee to business owner, one of the most important things you need to consider is how you’ll pay yourself. Yet this is one area that new (and even some seasoned) business owners continue to struggle with.
Although you went into business for yourself for many reasons, the ability to make more money was probably near the top of your list.
So why do you constantly feel stressed about figuring out how much to pay yourself, when to pay yourself, and what the most tax-friendly way to pay yourself is?
This week, I’m sharing tips for how to pay yourself as a business owner. You need to pay yourself consistently so you and your family are the top priority. After all, if you’re not feeling good about your personal finances, you’re not able to give your all to your business.
Two Ways to Pay Yourself as a Small Business Owner: Owner’s Draw vs. Salary
There are two main ways business owners can pay themselves: an owner’s draw or a salary. Taking an owner’s draw means that you withdraw money from your business profits on an as-needed basis. Paying yourself through owner’s draws offers you the flexibility to withdraw from your business account when there’s money in there – and not when there isn’t.
However, you don’t pay taxes upfront when you take an owner’s draw. Instead, you have to budget for taxes on your own. The taxes you set aside must include savings for self-employment taxes (the self-employment tax rate is 15.3%) as well as your income tax rate. And for some types of businesses, you’ll also need to save for employment taxes, sales tax, franchise tax, and property taxes.
Paying yourself a salary, on the other hand, means that you pay yourself a regular amount just as you would one of your employees. The benefits of paying yourself a salary are that you get to enjoy a steady income, making it easier to budget for both your personal finances and your business finances. Additionally, your taxes are deducted upfront when you pay yourself a salary.
On the flip side, if you pay yourself a salary, you have to continue paying yourself even if your business performs poorly for a season. This isn’t ideal for new business owners who don’t have a reliable picture of their business’s seasonal performance and average annual revenue.
Determine the Rules for Your Business Entity
Determining whether you should pay yourself a salary or an owner’s draw depends largely on how you’ve structured your business entity. If you’ve structured your business as a sole proprietorship, an LLC, or a partnership, you’re typically able to take owner’s draws.
But if your business is structured as a corporation or is an LLC taxed as a corporation, you can take a salary. How you’ve structured your business and how much revenue your business produces has certain tax implications, and in some cases, you may be able to benefit from different tax advantages. It’s always best to talk with your accountant to learn more about the tax implications that are dependent on how you pay yourself.
How Much Should You Pay Yourself as a Business Owner?
Deciding how much to pay yourself can be tricky. Depending on the type of business you own, you may have structured your pricing to fulfill your personal income goals (which, in my opinion, is always a good practice). But if you’re just starting out, you may have no idea how much to pay yourself as the business owner.
If you’re taking owner’s draws, you can typically pay yourself any profits after you’ve deducted that month’s business operating expenses and saved an appropriate percentage for taxes. If you’re transitioning to paying yourself a salary, consider how much you can reliably pay yourself that is comfortable for your personal finances, even on months when business may be slow.
Five factors you should consider when deciding how much to pay yourself include:
The business structure
The business’ performance
The business’ growth projections
Reasonable compensation (if paying yourself a salary)
Your personal needs and goals
You should also consider your business investment goals. If you have other sources of income and it’s important to you to have enough money to reinvest in the business for a specified amount of time, you may choose to pay yourself less until you’ve reached your business goals.
Avoid These 3 Common Mistakes
1. Mixing business and personal funds
Mixing business and personal funds is a huge no-no in the eyes of the IRS. It’s imperative to keep a business bank account that is separate from your personal bank accounts. Not only can mixing funds lead to an accounting nightmare, but it can also expose your personal assets to liability if a client or customer ever decides to sue you.
To avoid mixing business and personal funds, make sure to keep separate bank accounts and credit cards for your business. Never pay for personal expenses with a business credit card or check. Likewise, you’ll want to avoid paying for business expenses from personal accounts.
2. Failing to budget for taxes
Due to self-employment taxes, you’ll likely have to pay 30% or more in tax on the income you derive from your business. And if you’re paying yourself by owner’s draws, you’re responsible for making those tax payments yourself, as they do not automatically get deducted when you pay yourself. If you’ve failed to budget for those taxes, you may be in for a huge shock (and financial distress) come tax time.
Additionally, because you may not have any taxes withheld as a business owner, you’re responsible for making quarterly estimated tax payments to the IRS. Quarterly estimated tax payments are due January 15, April 15, June 15, and September 15. Failing to pay quarterly taxes could result in penalties to the IRS, so make sure to work with your accountant to determine how much you need to pay in estimated tax.
3. Paying yourself inconsistently (or not at all!)
Finally, don’t make the mistake of paying yourself inconsistently. As the business owner, you need to take care of yourself and your family so you can continue running the business well. It may be tempting at first to leave all your profits in your business bank account, but it’s important for your own wellbeing to properly budget and forecast so you can pay yourself consistently.
Partner With a Financial Business Coach to Pay Yourself Consistently
At Financial Fitness Coaching, I help business owners and entrepreneurs take control of their finances so they can pay themselves well and stop worrying about the health of their business. To see how I can help you develop a strategy to pay yourself more (and pay yourself consistently), email me at kristen@financialfitnesscoaching.com or simply schedule a free 20-minute Discovery Call on my calendar below!