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How to Pay Yourself as a Small Business Owner
by Fundid on Jul 6, 2023 8:00:00 AM
As a small business owner, it can be confusing to navigate the nuances of paying yourself and staying within legal boundaries. The way you pay yourself depends on the business structure you choose. There are different business entity types, ranging from sole proprietorships to C-corporations, and each has unique rules regarding paying oneself.
As a sole proprietor, for example, you would take money out of your business bank account whenever needed. But things are a little more complicated if you have a corporation or LLC. In this guide, we'll walk you through how to pay yourself as a small business owner, no matter what kind of entity you have.
The Different Business Entity Types
Before we can dive into how you pay yourself as a small business owner, you'll first need to understand what entity type your business is. If you haven't chosen a business type yet, this will also be helpful in guiding you through such an important decision. Not only does your business type determine how your business is taxed, but it also impacts your personal liability and how your business is structured. We’ll break down the different types of business entities and help you understand how they can affect your small business.
There are five main organizational structures to consider:
- Sole Proprietorship:
A sole proprietorship is an unincorporated business owned and operated by one individual. It is the simplest and most common form of business entity, mainly because it’s easy to set up and there are fewer legal formalities involved. The downside, however, is that your personal assets are at risk if the business is sued or incurs debt, and it can be difficult to raise capital.
- Partnership:
A partnership is an agreement between two or more individuals to run a business together. Partnerships can be general, where all partners are responsible for managing the business and its debts, or limited, where one or more partners have limited liability. Partners must agree on how to split profits, make decisions, and address changes in ownership. Like sole proprietorships, partnerships do not offer any protection for personal assets.
- Limited Liability Corporation:
An LLC is a hybrid entity that combines the liability protection of a corporation with the simplicity of a sole proprietorship or partnership. It is owned by one or more individuals, known as members, who have limited liability for the company’s debt and obligations. LLCs do not have the same formalities as corporations and are taxed as pass-through entities. This means that profits and losses are reported on the member's personal income tax returns.
- Corporation:
A corporation is a legal entity that is completely separate from its owners. It is owned by shareholders, who elect a board of directors to manage the company’s affairs. Corporations offer strong liability protection for their shareholders, but they require more formalities than other types of business entities. They must hold annual meetings, keep detailed records, and file separate tax returns. - Nonprofit:
A nonprofit organization is formed to serve a specific purpose other than making a profit. They are exempt from federal income taxes and many state taxes, and they are eligible to receive tax-deductible donations. Nonprofits are governed by a board of directors, much like a corporation, and they must adhere to certain regulatory requirements to maintain their nonprofit status.
Each entity type has its own advantages and disadvantages, and it’s important to carefully consider which one is right for you and your business based on your individual needs and goals for your business. Consulting with an experienced attorney or accountant can help you make an informed decision and ensure that your small business is set up for success.
Determine How Much to Pay Yourself
As a small business owner, determining your salary can be a tricky task. On one hand, you want to ensure that you are fairly compensated for the time and effort you put into your business. On the other hand, you also need to ensure that your business remains financially viable. To find that sweet spot, it is best to start by understanding your business's cash flow and expenses.
From there, assess your personal financial needs and consider the value you bring to the business. It is important to strike a balance between what you need and what your business can provide. By taking time to assess these factors, you can confidently determine a fair salary for yourself that supports both your personal and business goals. Remember, as a small business owner, you are an asset to your business and deserve to be compensated accordingly. Also, keep in mind that your salary may change as your business grows and evolves.
Now, let's dive into how you can pay yourself based on your entity type.
How to Pay Yourself if Your Business Structure is a Sole Proprietorship
Since a sole proprietorship is usually owned by just one person and does not involve separate legal paperwork for taxes, you can pay yourself out of the revenue of your business by transferring the funds into your personal checking or savings account. This is typically called a 'draw'. An owner's draw is money from the business for personal use. It is advisable to do this on a regular basis, like monthly or biweekly, to keep your personal finances in order. However, keep in mind that you will still need to pay taxes on the income that you take out from the business.
Related Reading: What is an Owner's Draw, and Why Is it Important?
Additionally, setting aside money each month for payroll tax payments is recommended so that you don’t owe hefty sums at the end of the year. These simple steps will help ensure a steady paycheck while further cementing your role as CEO of your own company and ensuring that this exciting journey continues to be enjoyable and prosperous in the future!
How to Pay Yourself if Your Business Structure is an LLC
If you have created a limited liability company (LLC) for your business, it is treated like its own entity, separate from yourself as the owner. This means that you are essentially an employee of your LLC and must pay yourself an income, just as you would any other employee. The two most common ways to do this are through a guaranteed payment or a distribution.
A guaranteed payment is a fixed amount of payment that you receive for services rendered, and it is subject to self-employment taxes. A distribution, on the other hand, is a portion of the company's profits that you take as an owner, and it's not subject to self-employment taxes. When owners are paid via distributions rather than wages, no payroll taxes are due, although individual income tax still must be paid. These distributions can be calculated based on the income of the LLC and should be reflected in the operating agreement of your business, especially if you have a multimember LLC. It is important to remember that when taking money out of an LLC, it must be done correctly in order to stay compliant with taxes and other regulations.
Related Reading: How Much Does an LLC Cost?
How to Pay Yourself if Your Business Structure is an S-Corporation
An S-Corporation, or S-Corp, is a type of corporation that is taxed like a partnership, where all profits and losses flow through to the shareholder's tax returns. As an S-Corp owner, you are considered both an employee and an owner, and you can pay yourself in salary and dividends. The salary is subject to payroll taxes, while the dividends are not.
How to Pay Yourself if Your Business Structure is a C-Corporation
If you own a small business structured as a C-corporation, the most straightforward way to pay yourself is by setting up a salary. This salary should reflect the amount of time and effort that you put into your business. The money drawn in salary will be subject to social security and Medicare taxes. It's important to consult with an accountant or financial advisor before establishing a salary plan, as they can help ensure you comply with applicable tax regulations and laws.
You can also pay yourself through dividends, but it is important to note that C-Corps are taxed at the corporate level, and dividends are also subject to double taxation: at the corporate level and the individual level. Paying yourself through a C-Corp structure is simple, cost-effective, and ensures proper regulation compliance - the perfect recipe for success!
Invest in a Payroll Software to Make Payday Easier
As a small business owner, it can be immensely satisfying to have something you can call your own finally. But, that satisfaction can quickly dissipate come payroll day. If you're feeling overwhelmed at the thought of crunching numbers and navigating employee data, investing in robust payroll software like Gusto is the way to go! It makes payday easier and ensures the accuracy of your paychecks.
With all kinds of features tailored to different entity types, you will save yourself both time and money in the long run. So don't be bogged down with paperwork anymore; let Gusto take the reins on payday - sign up now!
Don't Forget to Pay Yourself for Your Hard Work
Being a small business owner comes with many responsibilities - including knowing how to pay yourself! As a sole proprietor, you have the freedom to choose how you'd like to compensate yourself. When in doubt, consult with a tax specialist or an attorney to ensure that everything is done correctly and that you are not exposing yourself to unnecessary risks. By paying yourself regularly and appropriately, you can focus on growing your business and achieving your goals. Do you have any questions about how to pay yourself as a small business owner? Let our small business experts answer your questions.