Learning how to pay yourself as a small business owner is important. It will ensure you receive a fair salary and get a true picture of your company’s finances.
Typically, owners compensate themselves in one of two ways: a salary or an owner’s draw. This article will guide you through each option and help you determine what is reasonable compensation for your efforts.
Salary
Paying yourself a salary is important to your financial planning as a business owner. It helps establish a consistent income stream and keeps your personal and business finances separate, critical for tax and record-keeping purposes. It also enables you to focus on the goals and needs of your company instead of being distracted by personal finances, such as paying off debts or balancing budgets.
How to pay yourself as a business owner is just like an employee of the business, you pay yourself a monthly wage and deduct taxes from it. Companies organized as S-corps, C-corps, or LLCs subject to corporate taxation must comply with the IRS’s “reasonable compensation” standard. This means your pay should be comparable to someone in the same position in your industry.
Paying yourself enough to cover your basic living expenses is important during a startup. That includes rent, utilities, food and other essentials. It’s also good to strike all discretionary spending from your budget until your business has established itself. This will give you a sense of financial security, which can help you make better decisions for your business.
As a rule of thumb, your salary should be at least 30% of the total net profit of your company. The salary you need to pay yourself will vary depending on your industry and the number of employees in your business. If you need help determining how much to pay yourself, look up comparable jobs for similar work in your area. This will show you how much to set your salary for the first few months until your business grows and establishes itself.
Draws
One of the first decisions you must make as a business owner is to pay yourself a salary or an owner’s draw. The decision you make will affect both your personal and business tax liability. It’s important to consider the types of debt and obligations you have and any purchases you plan on making in the future when deciding between a salary and an owner’s draw.
An owner’s draw sometimes called an interest, is when a business owner takes money from the firm for personal use. Business owners might use a draw-in instead of paying themselves a wage. Owner’s equity, often known as your equity in the company, is the maximum you can withdraw. Although you are not required to pay taxes in advance each time you start money, it is a good idea to budget for your tax payment by routinely setting aside money.
A salary is a predetermined sum of money you will get regularly, with payroll taxes deducted. The advantage of a salary is that it provides a consistent payment and enables you to budget effectively for your personal and professional spending. The drawback is that there needs to be more compensation wriggle room, particularly when the company performs less well than anticipated.
A draw allows small business owners to withdraw funds from the company’s profits or capital as needed without issuing a paycheck or withholding income taxes. Withdrawals can be made by writing a check or transferring funds from the business bank account to your account. A draw is more flexible than a salary because you can take less or more funds based on the business’s health. Your draw quantity may occasionally change depending on your business. For instance, you might pay yourself extra during a busy period since your cash flow is higher.
Bonuses
A small business owner needs to think about a range of factors when it comes to their salary. They need to consider how much they need to live on (considering their credit card balances, long and short-term loans, and other financial commitments) while still being able to invest in their company and meet goals for the future. Self-care in your business is not being selfish. It’s imperative to keep moving forward and focus on the good things when you work for yourself.
And distinguish between creating your recognition strategy and engaging in self-care. To manage the highs and lows of being an entrepreneur, self-care and self-recognition work together to balance your thoughts, energy, and emotions.
Then, they need to consider what kind of bonuses they want to take from their company’s profits and revenue. Depending on the type of business they operate, there are different rules for how to do this. For example, C Corporations are subject to double taxation, while other business structures—called “pass-through entities” by the IRS—are not.
Bonuses can be a great way to reward yourself for your hard work as a small business owner and entice others to join your team. However, it’s important that any bonus amounts are based on profitability and can be paid consistently from company earnings. This will avoid any potential conflicts of interest.