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Running a business

Salary or Draw: How to Pay Yourself as a Business Owner or LLC

The most compelling aspect of running your business is that you get to pay yourself as a business owner. Unlike a corporate business structure, you are not dependent on others to either run the show or pay you for your efforts.

This means that you have the flexibility to decide how much you earn as a business owner, how much effort you put in, and thus earn the rewards of the efforts made.

There are many advantages to running your own business. Still, the major contention you face is how to pay yourself as a business owner?

The way you pay yourself as a business owner depends upon the type of business structure you choose. You receive a draw if you are a sole proprietor. Likewise, you distribute profits or losses based on the percentage mentioned in your partnership agreement if you run a partnership firm.

Similarly, single-member LLCs are like sole proprietors and draw funds from businesses. However, multi-member LLC is treated like a partnership firm where profits and losses are distributed among members.

In this article, we will discuss how to pay yourself as a business owner, that is, pay yourself from a sole proprietorship, partnership, and Limited Liability Company (LLC).

How Do I Pay Myself From My LLC?

A Limited Liability Company (LLC) is a business structure wherein the owners, also known as the members, are not personally liable for the company’s debts or liabilities.

Furthermore, the company pays the taxes and is considered a separate legal entity from its owners. For tax purposes, an LLC may be classified as a partnership or corporation or disregarded entity.

Some countries may not consider the members of an LLC to be employees. Therefore, the members do not take a salary. Furthermore, there are some types of LLCs – single-member LLCs and multi-member LLCs.

How Am I Taxed As The Owner Of A Single-Member LLC?

Considers a single-member LLCs as a sole proprietorship. This means that a single-member LLC is a disregarded entity.

A disregarded entity refers to a business structure similar to a sole proprietorship. In this, a single person owns the business and is not taxed separately.

This means that a disregarded entity is not required to file its tax return.

Rather, the business owner reveals his business profits on his return. Therefore, this means that the business and owner are separate from each other.

It is important to note here that a single-member LLC is separate from its owner legally. But the single-member LLC’s profits pass through to the owner’s tax return.

Therefore, there is no need for you as a single owner LLC to file a separate tax return for the LLC. The profits and losses of the LLC are passed on to you.

So, as a single owner of the LLC, you are required to report the LLC income on your tax return.

Furthermore, each state has its tax-filing requirements for LLCs. Therefore, you need to go through your state’s rules to ensure that all tax-filing requirements are met.

Besides considering yourself as a disregarded entity, you can even choose your LLC as a corporation.

Accordingly, you will be considered as an employee of your single-member LLC and may have to pay yourself a salary in place of a draw.

Choosing to consider your LLC to be a corporation may lead to a reduction in self-employment.

However, it may lead to other tax consequences and increased paperwork.

Receive Distributions From LLC Profits

The members of LLC receive distributions from the company’s earnings. These distributions are based on the amount of investment made by each member of the company as well as the terms and conditions laid down in the company’s operating agreement.

The operating agreement outlines the rules and regulations to manage the company as well as how LLC members share revenues and liabilities.

Furthermore, it also states the percentage of the company’s earnings that each member would receive and when such distributions of profits need to be made.

Work as an Independent Contractor

An independent contractor is an individual or entity that agrees to undertake work for another entity. The work is undertaken not as an employee but as one who provides services independently.

Typically, an individual is considered an independent contractor where the recipient of services or the payer controls or directs only the result of the work. Such a person does not guide on what work needs to be done and how.

Some countries may considers professionals providing independent services like doctors, lawyers, etc as independent contractors.

Such professionals working as independent contractors are a part of the gig economy. It is where people earn income by providing work on demand.

Furthermore, some countries may considers independent contractors either as sole proprietors or single-member LLCs. This means that independent contractors are recognised as self-employed.

Since you are considered self-employed, you do not receive a salary as an employee. Rather, you set your pay rates and payment schedules.

Accordingly, you are also not subject to pay any self-employment taxes.

An individual is considered to be a self-employed person if he:

  • Carries out trade or business as a sole proprietor or as an independent contractor
  • A member of a partnership that undertakes trade or business
  • Carries out trade or business for himself

What is an Owner’s Draw?

An Owner’s Draw is the amount of money that a sole-owner or a co-owner takes out from a Sole Proprietorship, Partnership, or Limited Liability Company for personal use.

However, corporations cannot take the owner’s draw. Such corporations take profits in the form of distributions or dividends.

These distributions are based on the percentage of the ownership an individual has in the company.

Furthermore, the distributions are expenses deducted from corporate earnings. Thus, as a business owner, you need to pay taxes on such earnings via your income tax return.

Thus, an owner’s draw is the way an owner pays himself rather than taking a salary from the business.

The funds drawn out of the business must be taken out of the business profits after paying all the business expenses.

Thus, technically the owner’s draw is not a salary. Rather, it is more of the owner’s equity.

How Does the Owner’s Draw Work?

You can make business withdrawals through a cheque from your business bank account. Thus, you can pay for your expenses once the funds are deposited into your account.

This is unlike the case of an employee who is paid a salary via a payroll service that deducts employment taxes automatically.

Now, from an accounting perspective, withdrawing funds from your business reduces your capital account. This is because you are taking out funds from the owner’s equity.

Owner’s equity is nothing but the amount of money you have invested in the business. Hence, whenever you withdraw money, you tend to lower the amount of the owner’s equity.

This can be explained with the help of the following balance sheet equation:

Assets = Liabilities + Owner’s Equity

How is Owner’s Draw Taxed?

The Owner’s Draws are not taxable on the business income. Rather, these are taxable as the income on the owners’ income tax returns.

Thus, if you are a sole proprietor, your draws are considered personal income and are taxed on your income tax return.

Likewise, some countries taxation system recognises partnerships similar to sole proprietorships. This means that the earnings generated via partnerships are treated as personal income.

However, in the case of partnerships, a single person does not have a claim on the revenue or profits of the business.

Instead, each partner has a share in the earnings generated based on the percentage of share stated in the partnership agreement.

Therefore, each partner includes his share of income in his income tax return. Furthermore, he is required to pay income tax and self-employment taxes quarterly.

Finally, the rules about the owner’s draw in the case of an LLC vary depending upon laws. Hence, you need to go through the laws before considering the owner’s draw and taxes on the same in the case of an LLC.

Also, as a business owner, you pay taxes from the owner’s draw as in the case of a sole proprietor or partner. This applies to both single and multiple-member LLCs.

Should I Pay Myself a Salary?

Your small business earnings are a reflection of the hard work that you had put in to bring your business to life. It’s quite a fascinating experience as a business owner.

However, the challenge that you face is how to pay yourself as a business owner. There are various factors that you should consider while deciding how to pay yourself.

Business Structure

The type of business structure is one of the primary factors that help in determining your payroll process. Your business structure would indicate the payment style that is relevant for your business.

The owners of sole proprietorships, partnerships, and LLCs are considered self-employed. Hence, they pay themselves through the owner’s draw.

This means they do not pay themselves regular wages. Rather, they take out funds from the business for their personal use.

However, you need to pay yourself a salary if you own a corporation and are engaged in its day to day operations.

Payment Method

There two ways in which you can pay yourself:

Owner’s Draw

The owner’s draw is the distribution of funds from your equity account. This leads to a reduction in your total share in the business. Also, you cannot deduct the owner’s draw as a business expense, unlike salary.

So, if you are a sole proprietor, a partner, or an LLC, you can go for the owner’s draw.

Furthermore, it is important to note that the owner’s draw is not taxed when it is taken out of business. However, you need to pay taxes on such draws while filing personal tax returns.

Salary

Salary refers to a fixed amount of regular payment paid every month. State and Federal governments tax such payments.

Therefore, you need to pay yourself a salary and not an owner’s draw if you own a corporation and are engaged in its day-to-day operations.

Amount of Payment

The next step is to calculate the amount of payment you need to make to yourself. This is after you have determined the appropriate payment method.

Generally, reasonable pay is the amount that a similar business would pay for the same or similar set of services.

You can consider the following factors to know whether the pay is reasonable or not:

  • duties performed
  • business complexity
  • cost of living
  • volume of business
  • time invested, etc

So, to determine how much to pay yourself, you also need to go through your P&L. This is to know the profits your business is generating.

Then you need to deduct your payment from the profits earned once all the business expenses such as rent, salaries, business supplies, etc have been deducted.

Schedule of Payment

You need to think about your payroll schedule if you are the only one who is running the entire show.

There are various ways in which you can pay yourself. These include weekly, fortnightly, semi-monthly, and monthly. Every state has its payroll schedule.

Therefore, you need to check with the department of labour as to under what payroll schedule falls.

Get Paid

The final step is to pay yourself. Once, you have decided your payroll schedule, you can pay yourself by either writing a check and depositing the same into your bank account. Or transferring funds directly into your bank account.

How Much Should I Pay Myself As a Business Owner?

There is no standard formula for how much you should pay yourself as a business owner. As a sole proprietor, partner, or LLC owner, you can legally draw as much as you want from your equity.

However, you need to consider all the aspects of your business finance. These include operating expenses, debts, taxes, and business savings while determining your pay.

For this, you would first have to look into the net income of your business. This is nothing but the income left after deducting all business expenses from your gross revenue.

After deducting business expenses, the next step is to find out how much you should save for your taxes.

Then, take into consideration your monthly debt payments and then plan for business savings which can be reinvested in the business.

Finally, after considering all the above parameters, you can now determine how much you can pay yourself.

To find out how much money would act as sufficient pay, you would first have to determine your personal needs.

You can first determine your fixed expenses like rent or mortgage. Then, you can work out the variable expenses that are necessary for living and that change each month. For instance, groceries, etc.

Do consider other expenses like phone bills, cable TV, dining expenses, etc. Accordingly, if you have a good amount of earnings, you can pay yourself well.

However, if the earnings are less, you need to have a clear understanding of your priorities in personal life and in business.

Business Taxation

Business taxes are nothing but the taxes that your business must pay as a part of its business operations.

The type of taxes you must pay depends upon the form of business you operate & where you operate.

What is Owner’s Equity?

Owner’s equity refers to the right of the business owners on the company’s assets. In other words, it is the portion of the company’s assets that the owners and its shareholders can claim.

Owner’s equity is calculated after subtracting all the liabilities from the total value of assets.

Typically, the owner’s equity is used for the sole proprietorship. In the case of an LLC or a corporation, the owner’s equity may be termed as shareholders’ equity or stockholders’ equity.

Owner’s equity includes:

  • the amount of money a business owner invests
  • business profits
  • (Less) money that the business owner withdraws
  • (Less) money owed to outsiders

In the case of a corporation, equity may also include:

  • Retained earnings
  • Common Stock
  • Preferred Stock
  • Additional Paid-In Capital
  • Treasury Stock

How to Pay Yourself as a Sole Proprietor?

As a sole proprietor, you are the sole member of your business. This means that you are a self-employed individual. Hence, you do not receive a salary as an employee.

Therefore, you can take an owner’s draw from the equity of your business. As mentioned above, an owner’s draw is the amount of money that you can take out from the owner’s equity for personal use.

The funds drawn from the business are deducted from your business earnings after paying all the business expenses.

When you draw funds from your business, it reduces your capital accounts and hence impacts your owner’s equity.

So, to make withdrawals, you can write a check against your business bank account and pay for your expenses. This is once the funds are deposited into your bank account. Also, the owner’s draws are not taxable on the business income. These are considered as part of your personal income and are taxed on your income tax return.

How to Pay Yourself in a Partnership?

Partnerships is similar to sole proprietorships. But, in the case of partnerships, a group of persons rather than a single person have a claim on the revenue or business profits.

This means each partner has a share in business earnings depending upon the percentage of share stated in the partnership agreement.

Since partnerships are similar to sole proprietorships, partners can also receive an owner’s draw based on each partner’s share in capital and business profits.

Furthermore, each partner includes his share of income in his personal income tax return. Thus, he is required to pay income tax and self-employment taxes.

How to Pay Yourself from a Limited Liability Company (LLC)?

An LLC is also similar to a sole-proprietorship or partnership firm. Therefore, the owner of an LLC can receive the owner’s draw instead of a salary.

However, the rules regarding the owner’s draw in the case of an LLC vary depending upon laws.

Therefore, as the owner of an LLC, you need to go through laws before considering the owner’s draw and its taxation.

How to Pay Yourself in QuickBooks?

Paying yourself an owner’s draw in QuickBooks is quite easy.

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