How to Pay Yourself as a Small Business Owner

The most compelling aspect of running your business is that you get to pay yourself as a One of the most appealing aspects of being a business owner is the ability to pay yourself. Unlike in a corporate setting, you are not reliant on others to manage the business or compensate you for your work. This grants you the freedom to set your own income, determine the level of effort you invest, and ultimately reap the benefits of your hard work.

But, while this all sounds fun and straightforward, you need to actually figure out how to do it — which can be a bigger task than you expect!

As a business owner, how you pay yourself depends on the type of business you have. If you're a sole proprietor, you get a draw. And if you have a partnership, you share the profits or losses according to your partnership agreement. Single-member LLCs are kind of like sole proprietors and they take funds from the business. But if you have a multi-member LLC, it's treated like a partnership where everyone gets a piece of the profits and losses.

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

Should I Pay Myself a Salary?

The profits of your small business are a direct result of your dedication to bringing it to fruition. As a business owner, this is an exciting experience. Yet, the dilemma lies in determining your own salary. There are several aspects to keep in mind when making this decision.

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 for personal expenses rather than regular wages. 

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:

1. 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.

2. 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 and determine the profits your business is generating. Then, deduct your payment from the profits earned once all the business expenses such as rent, salaries, or business supplies, ‌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, biweekly, 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 simply 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, 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 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 and other liabilities.

After considering all the above parameters, you can now determine how much you can pay yourself by understanding:

1. Your fixed expenses like rent or mortgage. 
2. Your variable expenses that are necessary for living and that change each month. For instance, groceries, phone bills, cable TV, dining expenses, etc. 
3. Your personal and professional priorities, and how much money would let you live the life you want without jeopardising your business’ success.

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 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 its own 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 ‌members of an LLC to be employees. Therefore, ‌ members do not take a salary as such. 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, and you are required to report the LLC income on your tax return.

Furthermore, each state has its own tax-filing requirements for LLCs. You will 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

LLC members are entitled to receive distributions from the company's profits, which are determined by their individual investments and the guidelines specified in the operating agreement. This agreement establishes the guidelines for managing the company, including how members will divide profits and responsibilities. It also outlines the percentage of profits that each member will receive and the timeline for distributing these earnings.

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 consider professionals providing independent services like doctors or lawyers as independent contractors.

Furthermore, some countries may consider independent contractors either as sole proprietors or single-member LLCs. This means that independent contractors are recognised as self-employed, and you would not receive a salary as an employee. Rather, you would 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 they:

• Carry out trade or business as a sole proprietor or as an independent contractor
• Are a member of a partnership that undertakes trade or business
• Carry out trade or business for themself

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 ‌ownership an individual has in the company.

Furthermore, the distributions are expenses deducted from corporate earnings, and 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. These funds must be taken out of the business' profits after paying all the business expenses. So 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?

Withdrawing funds for business purposes can be done by issuing a cheque from your business bank account. Once the funds are deposited, you can use them to cover your expenses. This differs from the process of an employee receiving a salary through a payroll service, where employment taxes are automatically deducted.

Owner’s equity is 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. 

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, meaning 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 their share of income in their income tax return. Furthermore, they’re 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. You need to go through your region’s laws before considering the owner’s draw and taxes on the same in the case of an LLC.

How to Pay Yourself as a Sole Proprietor?

As a sole proprietor, you are the sole member of your business and 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. 

How to Pay Yourself in a Partnership?

Partnerships are 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 their share of income in their personal income tax return, and they are 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 the laws before considering the owner’s draw and its taxation.

Tax Differences Between Sole Proprietorships, Partnerships, and Corporations

How to pay yourself as a sole proprietor - The business and the owner are a single entity in a sole proprietorship for tax purposes. This simplicity means sole proprietors report profits and losses directly on the owner's personal income tax return. The tax rate is based on individual income tax brackets, which can vary widely depending on the country. 

This structure also allows for straightforward deductions of business expenses, such as home office costs, supplies, and travel expenses, directly against business income. It's essential for sole proprietors to maintain meticulous records, as their personal and business finances are intertwined, impacting their overall tax liability.

Partnerships - Partnerships, which involve two or more people running a business, offer a different tax scenario. In partnerships, income is ‘passed through’ to the individual partners and reported on their personal tax returns, similar to sole proprietorships. Each partner pays taxes on their share of the profits at their individual tax rates. 

However, partnerships must also file an informational return to report their income, deductions, gains, and losses. This structure can be beneficial for partners with differing income levels, as it allows for income splitting.

Corporations - Corporations are unique in that they are taxed as separate legal entities from their owners. This means that corporations pay corporate income tax on their profits, and any dividends paid to shareholders are taxed again on the individual's personal income tax return. People often call this "double taxation," and it’s a critical consideration for business owners contemplating their corporate structure if their business grows.

However, corporations benefit from a broader range of deductible expenses than sole proprietorships or partnerships. These include employee benefits like health insurance and retirement plans, which can be fully deductible for the corporation while providing value to its employees.

Here’s a summary table covering all three:

We’ve mentioned tax deductions here a couple of times. Let’s examine common small business tax deductions more closely:

Small Business Owner Tax Deductions

Small business owners, regardless of their business structure, have access to a variety of tax deductions that can significantly reduce their taxable income. 

These deductions include expenses that are ordinary and necessary for running the business. Think of things like rent, utilities, office supplies, and salaries paid to employees. 

Perhaps less well-known, business owners can also deduct the cost of business insurance, marketing, and professional services like accounting or legal fees. Importantly, small business owners can also deduct the cost of business-related travel and even some meals and entertainment. 

These deductions lower the overall taxable income of a small business owner, helping to reduce the tax burden. Keeping accurate and detailed records of these expenses is crucial for substantiating these deductions during tax filing - which is where so many small business owners rely on QuickBooks Online to help with their accounting needs.

QuickBooks Online offers automated accounting for small business owners that helps to lighten their workload. With insightful reporting, automated invoicing, and help with tax compliance, QuickBooks Online can be an incredibly helpful partner in your enterprise.

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