There are many factors to consider when running a small business. One of the most important is how to pay yourself.

The best way to determine how much to pay yourself is by examining your company’s net monthly income, revenue minus operational expenses. From there, you can decide whether to take a salary or an owner’s draw.

Salary

The first thing that every business owner needs to do is make sure they have their personal and business finances separated. Commingling these two can create problems with bookkeeping, tax filings, and potentially even legal issues. Moreover, it’s essential to understand how to pay yourself as a business owner and the factors to consider when deciding.

Once the business finances are separated, it’s essential to consider how much money you will need from your business to meet your expenses. This will help you choose a salary or an owner’s draw.

Salaries are a good option for most small business owners, as they provide a steady and predictable source of income. They also allow the IRS to withhold taxes like they would at another job. When setting your salary, you should use similar salaries of other workers in your industry as a reference. The downside to this method is that it can be costly if the business is not profitable or you are not saving enough for tax payments.

A draw, or distribution, is a share of the company’s profits you can take out in cash. This is typically used by companies taxed as S corporations or C corporations. This type of payment can be a great way to manage cash flow for the business, but it’s important to note that you will still need to report the profit as your income and pay self-employment taxes on this amount.

Owner’s Draw

Whether you take an owner’s draw or receive a salary, you must decide which amount is most appropriate for your business. It would help to consider your current business cash flow needs and any upcoming expenses you may have to cover.

With an owner’s draw, you can withdraw funds from your company for personal use at regular intervals or as needed. This option offers flexibility since it’s not tied to a set payroll schedule or income tax withholdings. The only limit on an owner’s draw is that your total withdrawal for the year can be, at most, your equity in the company.

You can make an owner’s draw by writing a check, debiting your bank account, or electronically transferring money between accounts online. Owner’s interests can be tracked using a spreadsheet program, but it’s best to use a system that automatically calculates your taxes and sends payments to the correct taxing authority.

The owner’s draw method suits LLC owners, partnerships, and sole proprietorships. It’s important to note that you can’t use this method if your business is a C corporation or S corporation. Federal, state, and self-employment taxes are automatically withheld from your paycheck when you’re paid a salary.

These taxes are due quarterly and include Social Security and Medicare. The best way to calculate your federal and state tax withholdings is by using an accounting software program that automatically creates reports and sends payment instructions to the IRS and local business tax agencies.

Percentage of Profits

As an entrepreneur, you can pour as much or as little of your business profits back into the company as you like. The amount you choose should depend on your timeline, goals for growth, and personal financial needs. Investing your earnings into your small business is one of the best ways to ensure its long-term success, and it can be an excellent strategy for growing your wealth in the process.

Whether taking an owner’s draw or a salary, setting aside funds for emergencies and future expenses is essential. Make sure to keep your business and personal finances separate by maintaining a dedicated bank account for your business. This will help prevent commingling and make tracking expenses and available cash in your bookkeeping system easier.

If you are an LLC member who works in your business, you can be paid through profit distributions or owners’ draws, which pass on the business profits to owners. This is the most common way for small business owners to be compensated. However, there are some tax implications of this method. Owners may pay FICA, Medicare, and Social Security taxes on their share of earnings, so it’s essential to consider this when determining how much to pay yourself.

It’s also a good idea to review your percentage of profits periodically and compare it against the average income of your team members to see if you need to raise your wages. But always remember that a big part of being an entrepreneur is giving back to your business, so prioritize funding expansion over a pay bump when possible.

Dividends

You can receive dividends from your company’s profits as a business owner. This is a form of compensation that can supplement your salary or wages. It is important to note that a dividend is considered taxable income and may be subject to self-employment taxes, social security taxes, and state or local taxes, depending on where you live and the type of business you operate.

A regular corporate dividend is typically paid out every quarter, as this aligns with legal requirements for reporting earnings and coincides with the typical revenue cycle of many companies. However, there are no set rules governing the size and frequency of dividend payouts, so it is up to each corporation to determine its dividend policy.

For example, a company may use a “cash sweep” or “residual dividend” policy, where dividend distributions equal the excess cash remaining after taking care of the corporate capital needs. This is a popular option among mature, well-established corporations with a history of profitability and stability.

Other options for distributing profit include an interim dividend or a special one-time dividend. Interim dividends are payments made before the end of a financial year and are often based on forecasts and other calculations. A special one-time dividend is a payment made for any outstanding company shares.