Starting and running a business is an exciting journey, but it comes with its fair share of challenges and questions. One topic that often confuses both new and experienced business owners is how to properly pay themselves. In this blog post, we'll dive deep into this topic, covering three main areas: understanding how to pay yourself depending on your business entity type, determining how much to pay yourself, and setting up a system for paying yourself. Let's get started!

Understanding How to Pay Yourself Based on Your Business Entity Type

The way you pay yourself varies significantly depending on whether you operate as a sole proprietor, LLC, or S Corporation. Here's a breakdown:

Sole Proprietors and LLCs:

As a sole proprietor or a single-member LLC, you pay yourself by transferring money from your business account to your personal account. This is called an owner’s draw.

It's a straightforward process where you take money from the business profits to cover personal expenses.

S Corporations:

The IRS requires S Corporation owners to pay themselves as W-2 employees. This means you need to draw a regular paycheck with payroll taxes deducted, just as any other employee would.

In addition to your salary, you can take shareholder distributions from the net profits of the business. However, your salary must be "reasonable" and in line with what you would pay someone else for your role in the business.

Consulting with a tax professional is crucial to determine a fair salary and avoid any compliance issues with the IRS.

Determining How Much to Pay Yourself

Deciding how much to pay yourself depends on several factors, including the profitability of your business and your personal financial needs.

For S Corporations:

Your salary should be reasonable and reflective of fair market wages for your role.

You save on payroll taxes with an S Corporation compared to an LLC or sole proprietorship, but you still need to plan for personal income taxes on net profits.

Work with a tax professional to calculate the optimal salary and distribution amounts.

For LLCs and Sole Proprietors:

Consider your business’s profitability, your personal financial needs, and any business goals like paying off debt or saving for large purchases.

Aim to set a recurring monthly amount for your owner’s draw, which can help with personal budgeting and financial planning.

Remember to keep personal and business finances separate to maintain clear records and legal protections.

Setting Up a System for Paying Yourself

Creating a system for paying yourself can streamline the process and ensure consistency.

For Sole Proprietors and LLCs:

Set up automatic transfers from your business account to your personal account on a regular schedule (e.g., monthly or bi-weekly).

Avoid using your business account for personal expenses to maintain clear financial records and protect your legal standing.

For S Corporations:

Use a payroll processing company to handle your salary payments. This helps ensure compliance with payroll tax filings and reduces the risk of errors.

Companies like ADP and Gusto are popular choices due to their user-friendly platforms and comprehensive services.

Automate payroll to ensure timely payments and minimize administrative burdens.

By understanding these key points and setting up a structured system, you can confidently manage how you pay yourself and ensure your business finances are in good order. Consulting with a good tax professional will also equip you with the information you need to pay yourself properly.

If you have any questions, you can reach out via [email protected]

I hope this guide helps you navigate the complexities of paying yourself as a business owner. Remember, the right approach can make a significant difference in your financial management and overall business success. Happy business building! Check out the podcast below.

Disclaimer: This content is for educational and informational purposes only. Please consult with an accounting professional for direct advice based on your specific business situation.