Just like employees deserve a paycheck, business owners need to get paid. However, compensation methods can be tricky depending on your entity and business performance.
Whether you take a salary or owner’s draw, there are ways to make it effective for you and your company. Here are some of the most common options.
Salary
Paying yourself is a necessary component of running a business but also a complicated process. It can be tricky to balance the need for a healthy cash flow in your personal life and the needs of your business, especially as it grows and if you have employees. An accountant or bookkeeper can help you figure out an appropriate salary for yourself that’s both tax efficient and manageable in the long run.
There are a few different ways to pay yourself as an owner, depending on your business structure and level of involvement in your company. One way is to become a W-2 employee and have withholding taxes deducted from your paycheck. While this method is convenient for some, it could be better for some and has specific tax implications that should be reviewed with an accountant.
Another option is to take an owner’s draw from the business’s net profit (revenue minus all operational expenses). This allows for a great deal of flexibility regarding when and how much you withdraw, making it an effective way to meet your income requirements while keeping enough money in reserve to cover any unexpected lulls in revenue.
Whatever method you choose, it’s important to review your salary regularly. The amount should reflect how the company is performing while leaving you with a sufficient cushion to meet your personal spending needs and invest back into the company when possible.
Draw
As a small business owner, you must make decisions on various topics related to your company, including how much you should pay yourself. Whether you choose to receive a salary or owner’s draw, you must be sure to keep detailed records. This will help you save on taxes, maximize cash flow and maintain tax compliance. The decision to take a salary or owner’s draw depends on your business type and its stage. An owner’s interest allows you to withdraw discretionary money from your business, whereas a salary is a fixed amount paid regularly. An owner’s draw is common for sole proprietorships and disregarded entities, like single-member LLCs.
You must consider the size of your company and its assets, liabilities and current profits to determine how much you can withdraw from your company for personal use. It would help if you also accounted for your expenses and any investment and growth goals you have for the future. Consult a financial professional if you need help with the best way to pay yourself as a small business owner. They can advise you about each option’s benefits and disadvantages and help you decide which is most effective for your business. The decision can seem complicated, but it can be made easier with a little guidance.
Self-employment tax
A 15.3% tax rate is hard for many small business owners to swallow. Unfortunately, paying yourself for your company’s profits is what it takes. That’s because the IRS requires that you pay self-employment (SE) taxes, which are Social Security and Medicare taxes primarily for people who work for themselves. Employees have this tax withheld from their paychecks, but self-employed people must pay it directly, which they do via quarterly estimated tax payments throughout the year. As a side note, the good news is that half of SE taxes are eligible write-offs against your income tax returns — similar to how employers can deduct the employer portion of FICA (7.65%). You also may take advantage of a newly qualified business income (QBI) tax deduction, which applies to owners of S corporations, partnerships and LLCs, and sole proprietors.
It is important to remember that whichever method you choose for paying yourself, you’ll need to maintain detailed records. This includes tracking all expenses and liabilities and keeping accurate profit-and-loss statements for your company. Suppose you decide to pay yourself a salary from your business. In that case, you’ll need to ensure enough funds are in the company bank account to cover the payroll expense, plus any additional operating expenses.
Insurance
Aside from ensuring the business has enough money to pay its expenses, small business owners must also keep their finances healthy. This means calculating how much they need to take home each year. They should consider what they need for living costs and any other personal expenses that may come up throughout the year. To do this, they should calculate their business’s net income (also known as profit), which is calculated by subtracting the company’s expenses from its revenue. This number determines how much of a salary or owner’s draw they can afford to take from the business without putting the company at risk of financial trouble.
Once they’ve determined how much to pay themselves, they should ensure that the amount is consistent and recorded in their bookkeeping system. This ensures that the business can meet its obligations and prevents financial mistakes. Small business owners who need help with how to pay themselves best should consult an accountant. They can advise them on the best method based on their business’s current situation, including its development stage and tax status. They can also help them record and track expenses to avoid overpaying or underpaying themselves. Insureon makes it easy for small business owners to compare insurance quotes online to find the right coverage for their needs.
