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It’s not easy work, but owning your own business certainly has its perks. One of many is getting paid. Paying yourself as a business owner is an important transaction to do right to make sure you’re staying compliant with tax laws. We’ll go over different methods for paying yourself from your business, how to stay tax compliant, and how to determine what your paycheck should be.
Determine your business entity
Before you delve into the different ways you can pay yourself, you need to determine what type of business entity your business is (e.g., sole proprietor, LLC, corporation, etc.). Your business entity determines what kind of taxes you’re going to be responsible for and, ultimately, your options for paying yourself.
If you’ve chosen a business entity for your business already, that’s great. If not, you can read more about different types of business entities and learn which might provide the best structure for your business.
Ways to pay yourself
There are multiple ways to give yourself a paycheck. We’ll go over two ways to pay yourself based on your business entity.
Owner’s draw, or draw, is when the business owner takes money out of their business as a paycheck. You can do this if you’ve separated your business finances from your personal finances by opening a separate bank account just for your business. Then you would write a check to yourself. Alternatively, you can use your Square Balance like a business bank account and run owner’s draw by transferring money from your Square Balance to your personal bank account.
Businesses that can use owner’s draw to pay themselves:
- Sole proprietorship
- S corp (You have the option to take a draw in addition to your salary.)
Taxes you pay on owner’s draw
When you take an owner’s draw, your business is not taxed, but you are taxed when you do your income taxes. You also need to check if you are subject to self- employment taxes. Self-employment tax goes to Social Security and Medicare for business owners. The amount that you need to pay in self-employment taxes is dependent on your business’s profits. You pay self-employment tax when you do your income taxes.
If you pay yourself a salary, this would mean making yourself a W-2 employee, employed by your business. You would then pay yourself the same way you would run payroll regularly, with a set amount on a set schedule, with the right federal and state taxes withheld and paid to the correct agencies. One of the easiest ways to do this is by using a payroll service, like Square Payroll, that calculates the taxes for you and does the filings on your behalf.
Businesses that can pay themselves a salary:
- S corp (If you are involved in the day-to-day running of a business, then you must pay yourself a salary.)
- C corp
Taxes you pay on your salary
When you pay yourself a salary, you’re subject to all payroll taxes that W-2 employees have withheld from their paychecks. Additionally, there are some payroll taxes that employers pay on behalf of their employees. As the owner, you’re subject to these as well. The taxes that are withheld from your paycheck include federal income tax, state income tax, Social Security, and Medicare. The taxes that you have to pay as the employer include federal unemployment tax, state unemployment tax, Social Security, and Medicare.
Here’s a chart that breaks down which business structures use which methods to pay themselves.
||Method to pay yourself
||Owner’s draw, the same way a sole prop pays itself. If your LLC has more than one member, you would split the revenues.
||Owner’s draw, with the revenue split between partners.
||Owner’s draw and salary if you work in the business.
||Salary that is reasonable for the work you do for the corporation.
Decide how much to pay yourself
Regardless of whether you’re paying yourself a salary or taking an owner’s draw, you want to be aware of your business’s financial obligations and make sure you have enough to pay those bills. You also need to be sure that whatever amount you choose, it is reasonable for the duties you perform in your business.
When you’re paying yourself a salary, by definition it’s a set amount that you pay yourself regularly. When you calculate your salary, be sure the amount is sustainable for your business in the long term. When you’re paying yourself through owner’s draw, you have flexibility. You don’t need to stick to a certain amount or a set schedule.
In fact, a lot of businesses base the amount they pay themselves on their cash flow. If you’re just starting out and you have little to no cash flow, it isn’t uncommon for business owners to operate without taking a paycheck until their cash flow increases.
Regardless of the method that is best for your business, it’s critical that you pay yourself in a way that is compliant. Doing so opens up opportunities when it comes to applying for loans, bringing on investors, or other avenues you’ll want to explore when it comes time to grow your business.