Your small business needs money in the bank to pay the bills and meet your goals for the future. And, as the owner, you want to bring home a good income, or at least enough to feed yourself and keep a roof over your head. Paying yourself can sometimes seem like a tug of war between your needs and the needs of the business.
To strike the right balance, it's important to look at the numbers, decide how much money your business needs, and understand the way your income will be taxed. Here's an overview to help you get started.
Finding the magic number
Start by looking at the numbers: How much revenue is coming in, how much is going out in expenses, and how much cash do you have? Don't just look at this month's data—go back and see how your business has done over time. Project the amount of revenue and expenses you expect in the months to come. Don't forget to include:
- Taxes. Consider all that may apply to you: not only your personal and business income taxes but also payroll taxes and unemployment taxes.
- Occasional or annual expenses. Even though they occur less frequently, it's important to include expenses like insurance premiums and equipment repairs.
- Expansion plans. If you plan to move to a larger location, launch a more complex website, or expand your product line, you may want to accumulate cash in the business for that purpose.
- Expected fluctuations. An ice cream stand is going to do better in the summer than in the winter, and a service business may receive a big lump sum at the start of a major contract and then nothing for months.
Use this information to figure out how much money the business needs in its accounts to stay afloat, with a comfortable cushion, in case your projections don't prove to be true. This will tell you what's available to pay the owners.
Ways to pay yourself
Business owners can pay themselves through a draw, a salary, or a combination method:
- A draw is a direct payment from the business to yourself.
- A salary goes through the payroll process and taxes are withheld.
- A combination method means you take part of your income as salary and part of it as a draw or distribution.
The method you use will depend on your business structure and tax situation.
Salary or draw: How to choose
To choose a payment method, look at the type of business entity you have, for tax purposes. For example, LLCs may be taxed as sole proprietorships, partnerships, or corporations. A corporation may be taxed as an S corporation or a C corporation.
If you are a sole proprietor or in a general partnership, you are not an employee of the business, you are the business. This means you will pay yourself a draw, and you will pay estimated taxes quarterly, including estimated state and federal income taxes and your self-employment taxes, which cover Social Security and Medicare.
If your business is a corporation and you work in the business, you are an employee of the business and you should pay yourself a salary, with taxes withheld. You do not have to take all your compensation as salary—you also can take a draw or distribution.
In an S corporation, all business profits flow through to the personal tax returns of the owners. An owner's salary is subject to payroll taxes, but distributions of profits are not. Some S corporation owners see a tax savings by limiting their salary and taking the rest of their pay as a distribution. However, the IRS requires the salary to be reasonable for someone in your position with your level of experience.
It can be hard to figure out how a salary or draw will affect your business or personal taxes. It will help to get advice from a tax professional.
Getting paid
You'll need to decide how often to pay yourself. Biweekly is a common choice, but you also can pay yourself more or less often. At a minimum, pay yourself quarterly to stay on top of your tax obligations.
For a draw, you can just write yourself a check or electronically transfer funds from your business account to your personal one. A salary is more complicated because you have to withhold payroll and income taxes. You can handle payroll processing yourself, but many business owners use a payroll service that calculates taxes, sends payments to taxing authorities, and generates pay stubs and W-2 forms.
Once you start paying yourself, stick to a consistent schedule. Reevaluate things throughout the year—and make changes if needed—to make sure you are meeting your business goals and obligations, as well as your personal ones.
Find out more about Business Accounting
Learn more about LZ Books
FAQs
You can simply write a check to yourself from the business checking account or transfer money from your business account to your personal account on an as-needed basis. Salary: This payment goes through a payroll service and is usually made on a regular basis, such as weekly, bi-weekly, or monthly.
What percentage should I pay myself from my LLC? ›
Some tax professionals recommend paying yourself 60 percent in salary and 40 percent in dividends to stay clear of IRS problems unless this means your salary would be too low compared to others in your field.
What is the most tax-efficient way to pay yourself? ›
For tax efficiency, most company directors will choose to pay themselves a low salary and take any further money from the company in the form of dividends. This is because dividends are taxed at a lower rate than salary, and avoid national insurance contributions.
Can the owner of an LLC pay himself through payroll? ›
Paying yourself from an LLC can seem complicated, but it doesn't have to be. If the business is regularly generating revenue and you actively work in the business, you'll most likely pay yourself a salary or wages as an employee.
Can I transfer money from my LLC to my personal account? ›
That's called an owner's draw. You can simply write yourself a check or transfer the money for your business profits from your LLC's business bank account to your personal bank account. Easy as that!
Is it better to take owners draw or salary? ›
The answer is “it depends” as both have pros and cons. An owner's draw provides more flexibility — instead of paying yourself a fixed amount, your pay can be adjusted based on how well the business is doing or based on how much money you need.
Do I give myself a 1099 from my LLC? ›
If you choose to pay yourself as an independent contractor, you must file IRS Form W-9 with the LLC. The LLC then files IRS Form 1099-MISC at the end of the year. LLC members can also take a loan from the business. This option allows the members to access cash without affecting their tax liability.
How much should an LLC put away for taxes? ›
About 30-40% of your net income. This is a reliable rule of thumb because, on average small business owners make $66,000 or less, putting them into the 22% tax bracket or below. Add that to the 15.3% federal self-employment tax, and you're probably right in the middle of that range.
How much cash should I keep in my LLC? ›
The owner might decide to set aside $90,000 to $180,000 to cover three to six months' worth of expenses. But cash-flow can vary from month to month, so it's typically best to use a three- or six-month average for a more realistic view of how the business has been managing its cash.
Do owner draws count as income? ›
When you take an owner's draw, no taxes are taken out at the time of the draw. However, since the draw is considered taxable income, you'll have to pay your own federal, state, Social Security, and Medicare taxes when you file your individual tax return.
In every situation of distribution vs salary, it all comes down to what specific services are offered by the owner, whether they are replaceable, and whether the salary is reasonable. The savings can be substantial if the involved shareholder gets the reasonable compensation equation right.
How to determine how much to pay yourself? ›
If your business is established and profitable, pay yourself a regular salary equal to a percentage of your average monthly profit. Don't set your monthly salary to an amount that may stress your company's finances at any point.
How to do an owner's draw? ›
When taking an owner's draw, the business cuts a check to the owner for the full amount of the draw. No taxes are withheld from the check since an owner's draw is considered a removal of profits and not personal income.
How do I pay myself as a sole proprietor? ›
To pay yourself when you need money during the year, you take what's called a draw on the profits. Taking a draw simply means taking money from the business account and giving it to yourself. You could take out cash or write yourself a check. You can do it once a week, once a month, or randomly, as needed.
Do I have to pay taxes on money I put into my business account? ›
You pay tax on your business income (profit) regardless of whether you leave it in the business account or move it to a personal account to spend it.
Can I take money from my business account for personal use? ›
As the owner, that money may be technically yours, but your personal expenses must come out of personal accounts. When you routinely siphon money out of your business account to pay for personal groceries or mortgage, you don't have an accurate report on the financial health of your company.
How do I take money out of my small business? ›
One way owners can get money out of their businesses is by rewarding themselves and other family members who can work for them. This allows them to add their departure from the company as an expense to the company's wages, thereby taking it out of corporation tax and including the income in personal income tax.
How do I take money out of my own business? ›
The most common ways you may take or use money or assets from a company or trust are as:
- salary and wages – see employment income.
- fringe benefits, such as an employee using the business's car.
- directors' fees.
With an owner's draw, you'll take money from the business' profits, or capital you've previously contributed, by writing yourself a check or depositing funds into your personal bank account. You can take fixed draws at regular times or as needed.
