A Complete Guide to Paying Yourself As a Small Business Owner

As a small business owner, it can be easy to get caught up in the day-to-day grind and forget to pay yourself. However, setting aside money for yourself is essential to maintain your lifestyle and keep your business running smoothly. But how do small business owners pay themselves? Though this may seem like a no-brainer, you'd be surprised how many small business owners are unable to figure this out. Fortunately, there are a few different ways to pay yourself, and the method you choose will depend on your business's structure and financial situation. 

There are a few general principles that all small business owners should consider when paying themselves. This blog will discuss in detail a layout with different strategies for small business owners to pay themselves successfully. 

Why Does Owner Compensation Matter?

As a business owner, it's important to be compensated fairly for the work you do. After all, you're the one taking on the risk and responsibility of running a company. Owner compensation can come in many forms, but it is typically a combination of salary, dividends, and distributions. The amount of owner compensation you take should be based on what is best for your business and what you feel comfortable with.

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There are a few things to keep in mind when deciding how much should a small business owner pay themselves:

1. Expense Tracking: First and foremost, taking too much money out of your business can hurt its cash flow and make it difficult to reinvest in the business or pay other expenses. It is important to strike a balance between taking enough money to support yourself and your family and leaving enough money in the business to keep it running smoothly.

2. Tax Implications: Second, the tax implications of different types of owner compensation should be considered. Salary and dividends are taxed at personal income tax rates, while distributions are not subject to additional taxes.

3. Payment mode: Finally, it is important to have a clear and concise plan for how owner compensation will be paid out. This will help ensure that everyone is on the same page and that there are no surprises down the road.

Different Ways To Pay Yourself As A Business Owner

These are the three primary modes to get paid as a business owner:

1. Owner’s Draw

The first and most common method is an owner’s draw. An owner’s draw is simply when the business owner takes money out of business for personal use. This can be done at any time, and there is no limit to how much can be taken. The only requirement is that the owner keeps good records of all draws made to be properly accounted for come tax time.

Additionally,  it is important to note that an owner’s draw is not considered income and therefore is not subject to taxes. This can be a good option for business owners who want to minimise their tax liability.

2. Salary

The second way to pay yourself as a small business owner is with a salary. A salary is an amount of money that is paid to an employee for their work. As the business owner, you are considered an employee and can pay yourself a salary. Salaries are typically paid out regularly, such as weekly or monthly. 

One advantage of paying yourself a salary is that it is considered earned income and is therefore subject to Social Security and Medicare taxes. This can be a benefit if you are not yet eligible for retirement benefits. 

Another advantage of paying yourself a salary is that it can be used to show that you are serious about your business. This can be helpful when trying to obtain financing from lenders or investors.

3. Shareholder’s Distribution or Dividends

Shareholder distributions or dividends are the third way to pay yourself as a small business owner. A distribution is an amount of money that is paid out to the owners of a corporation. Distributions are typically paid out when the corporation has made a profit. Dividends are similar to distributions but are paid out of the corporation’s retained earnings. Both distributions and dividends are subject to Social Security and Medicare taxes. 

One advantage of paying yourself with shareholder distributions or dividends is that they are not considered earned income. This means that they are not subject to Social Security and Medicare taxes. 

Another advantage of paying yourself with shareholder distributions or dividends is that they can be used to show that you are serious about your business. This can be helpful when trying to obtain financing from lenders or investors. Paying yourself with shareholder distributions or dividends can also be a good way to minimise your tax liability. This is because distributions and dividends are only taxed at the shareholder level. This means that you will only be taxed on the money you receive as a distribution or dividend, not on the money the corporation earns. 

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When Can You Start Paying Yourself?

There is no set of rules, though it depends on a few factors. Such as the type of business you have, your profit margins, and your cash flow. If you have a service-based business, you may be able to start paying yourself sooner than a product-based business. Service-based businesses typically have lower start-up costs and higher profit margins.

If you have a product-based business, it is important to ensure you have enough money to cover the costs of goods sold before taking any money out for yourself. Once your business generates enough revenue, you can start paying yourself a salary or distributions.

Before you start paying yourself, ensure that your business brings in enough revenue to cover its expenses. Once your business is profitable, you can start paying a salary, dividends, or distributions.

If you structure your owner compensation as a salary, you will need to pay taxes on your earnings. Be sure to set aside enough money to cover your tax liability. If you structure your owner compensation as dividends or distributions, you may be subject to self-employment tax. However, you may be able to deduct some of your business expenses from the income and reduce the self-employment tax. 

How you pay yourself as a small business owner can affect your business. Consult an accountant or tax advisor to determine the best way to structure your owner's compensation.

How Do Small Business Owners Pay Themselves?

These are the factors that you need to lay down as in to determine how to pay yourself in a small business. 

1. Determine Your Business Entity

The first step in paying yourself as a small business owner. A business entity can be a sole proprietorship, a partnership, a corporation, or a limited liability company (LLC). However, let's observe the entities that suit small business owners. 

Sole Proprietorship

Sole proprietorships are the most common type of business entity. This is because they are the simplest and easiest to set up. A sole proprietorship is a business owned and operated by one person. The owner of the business is responsible for all of the debts and liabilities of the business. 

The advantage of a sole proprietorship is that it is easy to set up, and there is no need to file any paperwork with the state. Additionally, the owner has complete control over the business. The downside of a sole proprietorship is that the owner is personally liable for all debts and liabilities of the business. The owner’s personal assets could be at risk if the business fails. 

Partnership

A partnership is a business owned and operated by two or more people. Partnerships can be either general partnerships or limited partnerships. In a general partnership, all partners are personally liable for the debts and liabilities of the business. In a limited partnership, only the general partners are personally liable. The limited partners are only liable for the amount of money they have invested in the business. This makes it easy to figure out how to pay yourself in a partnership. 

The advantage of a partnership is that it is easy to set up, and there is no need to file any paperwork with the state. Additionally, partners can pool their resources and share the risks and rewards of the business. The downside of a partnership is that partners are personally liable for the debts and liabilities of the business. If the business fails, the partners’ assets could be at risk. 

Single Member LLC

A single-member LLC is a business owned and operated by one person. The business owner is not personally liable for the debts and liabilities of the business. If the business fails, the owner’s assets are not at risk. 

The advantage of a single-member LLC is that the owner is not personally liable for the debts and liabilities of the business. The downside of a single-member LLC is that it can be more expensive to set up than a sole proprietorship or partnership. Additionally, the owner may have to file additional paperwork with the state. 

Multi-Member LLC

A multi-member LLC is a business owned and operated by two or more people. The LLC members are not personally liable for the debts and liabilities of the business. The members’ personal assets are not at risk if the business fails. 

The advantage of a multi-member LLC is that the members are not personally liable for the debts and liabilities of the business. The downside of a multi-member LLC is that it can be more expensive to set up than a sole proprietorship or partnership. Additionally, the members may have to file additional paperwork with the state. 

2. Determine How Much You Should Pay Yourself

Once you have determined your business entity, you need to determine how much you should pay yourself. There are a few factors that you should consider when making this decision:

Business Structure

The type of business entity that you have will affect how much you can pay yourself. For example, suppose you have a sole proprietorship. In that case, you can only pay yourself the amount of money that is left after you have paid all of the business's expenses. If you have a partnership, you can only pay yourself the amount of money left after you have paid all of the business's expenses and all of the partners have been paid their share. 

Business Performance

The performance of your business will also affect how much you can pay yourself. If your business is not doing well, you may need to reduce your salary to keep the business afloat. On the other hand, if your business is doing well, you may be able to increase your salary. 

Business Growth

The growth of your business will also affect how much you can pay yourself. If your business is not growing, you may need to reduce your salary to invest in the growth of the business. On the other hand, if your business grows, you may be able to increase your salary. 

Reasonable Compensation

You should only pay yourself a reasonable amount of money. This means you should not pay yourself more than what you would pay someone else for doing the same job. Additionally, you should not pay yourself more than what the business can afford to pay. 

Personal Needs

You should also consider your personal needs when determining how much to pay yourself. If you have a family to support, you may need to take a lower salary to make ends meet. On the other hand, if you are single and have no dependents, you may be able to take a higher salary. 

Business’s Future Goals

You should also consider the future goals of your business when determining how much to pay yourself. If you are planning on growing your business, you may need to reinvest some of your earnings back into the business. On the other hand, if you plan on selling your business, you may want to take a higher salary to maximise your earnings. 

3. Figure Out The Best Payment Method: Salary Vs. Draw

Once you have determined how much you should pay yourself, you need to figure out the best payment method. This is one of the essential factors in determining how to pay yourself as a small business owner. The two most common methods are salary and draw. 

Salary

A salary is a fixed amount of money you pay yourself every period. The advantage of a salary is that it is predictable, and you will always know how much money you will be paid. The downside of a salary is that it is subject to income taxes and payroll taxes. 

Draw

A draw is money you take out of the business as needed. The advantage of a draw is that it is not subject to income or payroll taxes. The downside of a draw is that it is not predictable, and you may not always know how much money you will be paid. 

4. Pick A Payroll Schedule

Once you have figured out the best payment method, you must pick a payroll schedule. The most common payroll schedules are weekly, bi-weekly, and monthly. 

Weekly

With a weekly payroll schedule, you will pay yourself every week. The advantage of a weekly payroll schedule is that you will always have money coming in. The downside of a weekly payroll schedule is that it can be expensive to set up and maintain. 

Bi-Weekly

With a bi-weekly payroll schedule, you will pay yourself every two weeks. The advantage of a bi-weekly payroll schedule is that it can be less expensive to set up and maintain than a weekly payroll schedule. The downside of a bi-weekly payroll schedule is that you will not always have money coming in. 

Monthly

With a monthly payroll schedule, you will pay yourself once per month. The advantage of a monthly payroll schedule is that it can be the least expensive to set up and maintain. The downside of a monthly payroll schedule is that you may have to wait longer for your money. 

5. Get Your Paycheck

Once you have set up your payroll schedule, you will need to get your paycheck. The best way to do this is to set up a direct deposit with your bank. This way, the money will be automatically deposited into your account, and you will not have to worry about cashing a check. 

If you are paid in cash, you must go to the bank and cash your paycheck. Keep track of all the money you take out of the business to accurately report it on your taxes. 

Other Considerations For Paying Yourself As A Business Owner

There are a few other things to remember when paying yourself as a business owner. Let's have a look at them. 

1. Social Security And Medicare Taxes

If you are paying yourself a salary, you must pay social security and Medicare taxes. The current social security tax rate is 6.2%, and the Medicare tax rate is 1.45%. If you are paid a salary of $1,000, you will owe $62 in social security taxes and $14.50 in Medicare taxes. 

2. Risks Of Taking Large Draws

If you take large draws out of your business, you may risk your business. If your business runs into financial trouble, you may not be able to get the money back that you have taken out.  

Plus, taking large draws may be difficult to prove to the IRS that the money was used for business purposes. This could lead to an audit, and you may owe back taxes. 

3. Tax Considerations

When you are paid a salary, you will owe income taxes on your money. When you take a draw, you will not owe any taxes on the money until you withdraw it from the business. 

Self-Employment Tax

If you are self-employed, you will need to pay self-employment tax. This tax is used to fund social security and Medicare. The current self-employment tax rate is 15.3%. 

Federal Income Tax

You will also owe federal income tax on the money that you make. The federal income tax rates range from 10% to 37%. In addition to federal income tax, you may also owe state income tax. The state income tax rates vary from 0% to 13.3%. 

4. Retirement Plans

If you are self-employed, you can contribute to a retirement plan. The most common retirement plans for self-employed individuals are Solo 401(k)s and SEP IRAs. With a Solo 401(k), you can contribute up to $19,500 per year ($26,000 if you are over 50). A SEP IRA can contribute up to $58,000 per year. 

5. Health Insurance

If you are self-employed, you will need to purchase your health insurance. The good news is that you can deduct the cost of your health insurance premiums from your taxes.

Wrapping Up!

As a small business owner, it can be difficult to figure out how do you pay yourself in a small business. You wear many hats and often do not have time for bookkeeping and accounting. That’s where we come in. That’s why Fincent was created ~ to help small business owners pay themselves without worrying about complicated tax laws or deductions. Use our platform to make payments to yourself as an owner and take one more thing off your plate. 

Have you tried using Fincent yet? You will be amazed by the payroll capabilities.