Here are the fundamentals on how to pay yourself

Kudos on getting your small business started - that’s a tremendous accomplishment! During all of your planning, did you work out how you will be earning an income as the owner of a small business?

When stepping into the world of entrepreneurship, so many ideas and thoughts run rampant. Many, however, overlook the step about paying themselves, but it’s an integral part of your business plan. How you structure your business provides you with the options available to you to pay yourself. Read on to learn more.

First, separate business and personal finances

Before you even begin to figure out which option you’ll choose to pay yourself, it’s essential that you have your business and personal finances separated. Your business should have its own bank account. In addition to a bank account, it’s a good idea to apply for a credit card for your business. Use this card to make purchases that are then paid for using your business bank account. This is a great way to build the credit of your small business – which will be very valuable as your business grows.

In general, there are two options for business owners to pay themselves; owner’s draw or salary. The method that’s best for you will depend on a number of factors. Your business structure makes a difference, as does your personal financial situation. It would be wise to consult with an accountant or financial advisor to help you identify which method works best for you and your small business.

Related: How to decide which business structure is right for you

What is an owner’s draw?

An owner’s draw is one way small business owners pay themselves. This simply means that you withdraw your pay from the profits of your small business. It’s important to note that you must account for all of the business expenses, first, in order to be sure of the profits from which you’ll be withdrawing from.

The owner’s draw is a popular method for sole proprietors to pay themselves. Essentially, they pay the business’s expenses, put aside any funds that they earmark for future expansion or anticipated expenses, and pay themselves the rest. 

Keep in mind, at the time they are paid, owner’s draws are not subject to Social Security, Medicare, or income tax withholding. As you will need to report the income you’ve earned when you file, it’s a good idea to keep some money aside to account for the taxes you will owe. You may also be required to pay quarterly income taxes in this situation. Keeping meticulous records will definitely aid in avoiding any issues or surprises when tax day comes around.

Is it easier to pay myself a salary?

The other option for small business owners is to pay themselves a salary. Just as you would if you were working for another company, you would receive regular paychecks written from the business. If you have employees, you can pay yourself on the same schedule you use for them. Or, if you’re a sole proprietor, you can choose a schedule that works for you – weekly, bi-weekly, semi-monthly, or monthly. 

The notable difference between paying a salary and an owner’s draw is that taxes will be withheld from your pay if you pay yourself a salary. If you’re the owner of an S-Corporation or an officer of a C-Corporation, you are required by law to receive a salary with tax withholding.

Using a payroll company can help you stay on top of the tax reporting requirements associated with paying salaries, even if you’re a sole proprietor. When you withhold taxes, you need to submit those withholdings to the IRS on a regular schedule, and you need to generate the appropriate tax forms at the end of the year. A payroll provider will automate all of this for you, making the process seamless and reducing the chances you’ll make a mistake. 

How much to pay yourself?

Deciding on the salary you pay yourself is an important decision. Some small business owners look to see what the average salary is for the type of business and job performed. It’s a good method, however, some business owners don’t want to commit to an exact dollar amount - they’d prefer to take a percentage of the profits the business is making. This allows for growth and loss fluctuations.
Additionally, if you’ve hired top talent to help with your business and you’re paying them minimal salaries, you may not want to over-inflate your own salary. It could make for a hostile work environment and really bring morale down.

It may be surprising, but according to Payscale, the average small business owner salary is just about $62k per year. Do your small business the due diligence it deserves and research what a fair salary would be for you.

What if I don’t want or need to be paid by my small business?

For small business owners who have passed the start-up phase, it’s really a good idea to begin paying yourself. As the owner, it shows your commitment to your business and your desire to see your business grow. Taking a salary shows loan and funding officers as well as future investors that you are confident in your business and comfortable paying yourself.

Aside from that, paying yourself also identifies to the IRS that you are running and operating a legitimate business. 

There’s also the matter of paying your bills. If you’re in a situation where you don’t need the income from your business in order to do this, consider paying yourself a salary and earmarking the money for retirement savings or some other goal. 

Related: Choosing a retirement plan for your business 

Tools to help

There are a wealth of tools available to help you with your business. If you do your own accounting it’s likely that you already have a financial program like QuickBooks that you use to organize your business expenses, sales, taxes, payroll, etc. You can use this software to pay yourself and your employees, if you have them.  

The U.S. Small Business Administration (SBA) offers a great deal of information for starting and managing your small business. You can always reach out to them for guidance and assistance for any questions you might have.

Protect your business – and your salary

Regardless of whether you decide to take an owner’s draw or a salary, you want to spend your business’s revenue on things that will help your business grow, in addition to paying yourself and your employees. Don’t spend the money your business generates on paying claims and lawsuits when you could protect yourself with business insurance. Learn what you need and get a quote today at Hiscox.com.