Running your own business doesn’t mean you sit around as stacks of cash come flooding into your office. Business owners are busy nonstop to keep up with operations. Since running a business is your full-time job, you need to know how to pay yourself from your business.
How to pay yourself from your business
How do small business owners pay themselves? Typically, you’ll either pay yourself a salary or an owner’s draw.
An owner’s draw or distribution is a portion of the business’s profits that your company distributes to you as your payment.
A salary is a fixed amount that you pay yourself each pay frequency (similar to how you pay employees a salary)
Different factors determine whether you pay yourself an owner’s draw or salary—and how much you receive. These factors include:
- Business structure
- Profits
- Expenses
- Reasonable compensation guidelines
Learning how to pay yourself as a business owner will require you to consider every factor.
How to pay yourself #1: Business structure
The best way to pay yourself as a business owner will depend on your type of business structure.
| Business Structure | Owner’s Draw or Salary? |
|---|---|
| Sole proprietor | Owner’s draw |
| Partnership | Owner’s draw |
| LLC | Owner’s draw (if treated like sole proprietors/partners) Salary (if treated like corporations) |
| C Corp | Salary (and dividends) |
| S Corp | Salary (and dividends) |
How to pay yourself as a sole proprietor
As a sole proprietor, you are the only owner of your business. Sole proprietorships are only taxed at the personal level. You and your business are considered the same legal entity, meaning you are liable for your business’s liabilities. So, how do sole proprietors pay themselves?
In a sole proprietorship, your compensation comes from a draw payment. You can take out as much as you want from your business’s profits since you are entitled to all your business’s money.
According to the Self-Employment Contributions Act (SECA), you must pay self-employment tax and estimated taxes on your income. Attach Schedule C to Form 1040, U.S. Individual Income Tax Return.
How to pay yourself from a partnership
A partnership is a business owned by two or more people. Partners are the same legal entity as their business, much like the tax entity of sole proprietors. Partnerships are pass-through tax entities, meaning the owners are responsible for paying their share of taxes.
How do partners get paid? If you are part of a partnership, you will take an owner distribution. Partners are considered self-employed, so you must pay SECA tax.
To file taxes, attach Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., to Form 1040.
How to pay yourself from an LLC
A limited liability corporation (LLC) combines aspects of partnerships with corporations. Owners have shared tax responsibilities, but owners are not the same legal entity as their business. You must know how to pay yourself from an LLC:
Single-member LLCs are disregarded entities and treated as sole proprietorships. If you are a single-member LLC, you will receive LLC distributions from your business’s profits. You must attach Schedule C to Form 1040.
Multi-member LLCs are treated as partnerships. Each owner pays their portion of taxes. You and the other members of the LLC receive draws from your business’s profits. You must attach Schedule K-1 to Form 1040.
Multi-member LLCs can elect to be treated as a corporation or S Corp. In this case, you would receive a salary.
How to pay yourself from a C corporation
In a corporation, the business is legally separate from the owners. Because of this separation, you have limited liability for the company.
If your business is set up like a corporation and you are actively working for the business, you will receive a salary just like an employee. If you own stock in the corporation, you can also receive dividends.
Corporations are double-taxed, meaning the business is taxed and the business’s profits are taxed through each owner’s income. You will be taxed as an employee and pay FICA tax.
How to pay yourself from an S Corp
An S Corp separates the company from the owners, like in a C corporation. You are not double-taxed if you are an S Corp, but you still have limited liability for the company.
An S Corp owner can receive both wages and a distribution. If you work in the company, you will receive a salary. The salary will be taxed like normal employee compensation. You will have FICA tax taken out.
How to pay yourself as a business owner #2: Profits
Before you start taking a hefty paycheck, make sure your business is profitable. If your business is barely getting by, lower your personal income.
When you have a healthy small business cash flow, you can increase your pay. You might want to base your income on your business’s income.
Small business owners typically limit their wages to 50% of their business’s profits. You want to make sure that your business will retain enough of its profits to continue growing and operating efficiently.
How to pay yourself #3: Expenses
As a business owner, you have all sorts of expenses. You need to pay taxes and overhead expenses like insurance and inventory.
When you’re considering how to pay yourself from your business, take a look at your profits and expenses. If you have less coming in than going out, you might need to take a temporary pay cut.
If you have employees, you need to pay wages, training costs, and benefits. As an employer, you are responsible for making sure your employees get paid via payroll before you pay yourself. Make sure all your expenses are accounted for when determining your pay.
How to pay yourself #4: Reasonable compensation
How much do other business owners get paid? Reasonable compensation is the amount of payment someone would be paid for similar work under similar circumstances at a different business.
When asking how to pay yourself from your business, take into account reasonable compensation. Consider your value to your business. Research how much people are paid to do similar tasks to those you perform.
Make sure you compare yourself to people who manage businesses with similar:
- Sizes
- Locations
- Industries
If the IRS thinks you are excessively paying yourself from your company, they may investigate your business’s spending. Base your paycheck on your comparison research.
Have employee expenses on your plate? With Patriot’s online payroll software, you can run payroll in three easy steps. Our software supports all common pay frequencies (e.g., biweekly) as well as less common schedules (e.g., quarterly). Try it for free today!
This article has been updated from its original publication date of November 4, 2014.
This is not intended as legal advice; for more information, please click here.
