How to Pay Yourself as a Small Business Owner

Tools and Resources

Get the Full Course

Create your free Business Center account to get access to the complete Small Business Startup Course and all the worksheets.

Get Started Now

Resources

• Simple Payroll Software: QuickBooks
• Advanced Payroll Software: ADP

Draws vs. Distributions vs. Salaries – What’s the Difference?

Determining how to pay yourself is influenced heavily by your business's legal structure. LLC owners with default tax structure typically pay themselves with a draw or distribution, while corporation owners must typically pay themselves a salary. Each structure (and each pay process) comes with their own advantages and disadvantages come tax time.

How to Pay Yourself as a Small Business Owner – Transcript

Let's face it: if you're an entrepreneur, one of the reasons that you're in business in the first place is probably to make money. And if you're good at what you do, there's a good chance that the business you create will make money. 

But taking money out of your business is not as simple as just taking money out of the cash register and putting it into your personal bank account. And taking money out of the business you create the wrong way because you financial or even legal trouble in the future. Not to worry, though – we'll be covering everything that entrepreneurs need to know about paying themselves in this video. 

Hey everybody, Will Scheren here from Small Business Startup Guide by TRUiC. This video is part of a larger course dedicated to helping small business owners cut through the noise and get to the essentials of starting and operating their business. If that sounds like it would be really useful to you, be sure to like and subscribe. 

Figuring out how to pay yourself as an entrepreneur is a three-step process. First, you need to consider which legal business entity you filed your business as. Next, you needed to determine how much you should be paying yourself. And lastly, you need to establish a payment method. But before we dive into the how of paying yourself as an entrepreneur, we should quickly cover some of the vocabulary surrounding the topic. 

Owner’s draws are the way that most single-member small business owners get paid. It simply means that you'll draw money out of your business for personal use. Rather than receive a set amount of money at a set time, you decide when and how much money to take out of your company. When owners in multi-member LLCs take money out of their business's profits, it's called an owner's distribution. 

Salaries are a fixed amount of money at fixed times that an owner receives for the work that they do in their business. Some business types are required to use the salary method to pay owners if they work as an employee within the business. 

If your company has shareholders, it may pay dividends or distributions out of the company's profits. These may come in the form of cash payments, shares of stock, or other property, and they’re taxed differently than owner’s draws. It's possible to receive dividends or distributions in addition to a regular salary. 

How business owners should pay themselves – Step 1: Determine your business entity. Earlier in the course, we explain that businesses should work with an accountant and a lawyer to set themselves up as either a single-member LLC, a multi-member LLC, an S corporation, or a C corporation. 

Single-member LLC owners are paid with an owner's draw, and multi-member LLC owners are paid through owner’s distributions. All LLCs are pass-through entities, meaning that all profits are passed through to the business owners. Paying the owners can be as simple as using the business account to write a check or doing an automated clearinghouse or ACH transfer. Owners will pay taxes on any income when they file their personal income taxes. 

If you set up your business as an S corporation or a C corporation, then you'll need to pay yourself differently. An owner of a corporation that works within the business is considered an employee, and they should be paid a W-2 wage. All employees of a business other than owners of an LLC should fill out a W-2 tax form when they begin their work. We'll talk more about how to handle paying W-2 employees in the next video in the course. 

If, however, any business owners only perform minor services or don't perform any services at all, they should not receive pay as an employee. All corporation owners can also receive shareholder distributions or dividends – even if they're also receiving a W-2 salary. 

There are some tax benefits to structure your company as an S corporation because the distributions aren't subject to self-employment tax. Whereas owner's draws or distributions taken in as sole proprietorship or partnership are subject to self-employment tax. You should work with an accountant to set up your owners' salaries and distributions to ensure that they're taxed appropriately. 

Step 2: Determine how much to pay yourself. When it comes time to decide how much you can pay yourself, there's a few things you want to consider: how much do you need to earn, what's the lowest amount you're allowed to pay yourself, and what are your company's plans? 

How much do you need to earn – You can't be expected to live without earning an income. What do you need to cover your personal expenses? If your business is your only source of income, when deciding how to pay yourself, start by figuring out the minimum amount of money that you need to be taking home on a monthly basis. 

The lowest amount you're allowed to pay yourself – owners of LLCs do not have stipulations on the minimum amount of money they're allowed to take from their business since they'll be taxed on any amount of money the business makes, whether they move it from their business account or not. 

However, since corporation owners are taxed more for their W-2 wages, you're not allowed to pay yourself with the smallest salary possible and then pay yourself more in dividends and cash distributions. The IRS requires that officers of a corporation be paid a “reasonable compensation,” which corresponds to their responsibilities and duties. 

Most tax accountants will want you to come up with your reasonable compensation amount by either looking at what it would cost to pay someone else to do the work that you do or estimating the fair market value of the services that you provide when establishing how owners should be paid through W-2 wages and distributions. 

What are your company's plans – when deciding what to pay yourself, keep in mind that, as we discussed earlier in the course, your business should be operating with a financial goal and should be on a budget to obtain that goal. As the owner of a small business, your job is to ensure that your business is growing each month and that it's growing in a way that leaves it able to pay its debts, pay for everything that it needs to remain operational, and is remaining profitable. 

It may be tempting to cut yourself a substantial paycheck, especially after years spent putting your livelihood on the line to launch a business. But the more cash that you siphon off from the business to your personal account, the more financial stress you'll be placing on the business, which can restrict your business's growth. Always consider the full picture of your business's long-term goals and budget when considering how much you'll pay yourself as a business owner. 

Step 3: Determine the payment method. Now that you know how much you're going to pay yourself, it's time to figure out the mechanics of how to actually do that. 

First, ensure that you've separated business and personal finances. We've mentioned this multiple times in the course already, but your business finances and personal finances should be kept separately. And a good way to do this is by opening a business checking account. Even as a sole proprietor, you'll want to keep your money separate because it helps maintain accurate record keeping, which will definitely help at tax time. 

Next, consider paying yourself consistently. Even if your business is set up as an LLC, one of the best things you can do when determining how to pay yourself is to pay yourself consistently. Whether it be monthly or more, that consistency helps with planning – both personally and in your business. When you pay yourself consistently, you have a better handle on what your business's cash flow needs are. 

Use ACH payments or checks. For business structures where you take owner's draws or distributions, paying yourself can be as simple as writing yourself a check or making an ACH transfer from your bank account. Just make sure that you do the proper bookkeeping each time that a payment to the owner is made. 

Finally, consider a payroll service. As you can see, paying yourself and even your employees isn't rocket science, but it does require attention, and doing it incorrectly can be very costly. If your business can afford a payroll service, you should consider investing in one so that you, as the owner, can keep your attention on actions that drive your business forward. 

We’ve provided a discount link below this video to QuickBooks Payroll, which is our recommended payroll service provider, and we'll be taking a look at running payroll for your employees in the next video in the course. 

This video is part of a step-by-step course that provides business owners all of the essential information for starting and operating their business. We’ve provided a link below this video for you to get access to all of the free and discounted business tools we mention in this course. 

Be sure to like and subscribe to get more of this content. We’ll see you in the next video, and if you have any questions, let us know.