In this article, you will learn:
- How Do I Pay Myself From My LLC?
- How Am I Taxed As The Owner Of A Single-Member LLC?
- Receive Distributions From LLC Profits
- Work as an Independent Contractor
- What is an Owner’s Draw?
- Should I Pay Myself a Salary?
- How Much Should I Pay Myself As a Business Owner?
- Business Taxation
- What is Owner’s Equity?
- How to Pay Yourself as a Sole Proprietor?
- How to Pay Yourself in a Partnership?
- How to Pay Yourself from a Limited Liability Company (LLC)?
- How to Pay Yourself in Quickbooks?
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.
IRS does not consider the members of an LLC to be employees. Therefore, the members do not take a salary. Furthermore, there are two types of LLCs – single-member LLCs and multi-member LLCs.
How to Pay Yourself As a Business Owner in a Single Member LLC?
You can choose to pay yourself from an LLC in either of the following ways:
Pay Yourself a Salary
The major benefit of paying yourself a salary, just like an employee, is that you have a regular income. Paying yourself as an employee is the most ideal option if a certain amount of income is important to meet your requirements.
So, the amount of salary that you pay yourself must be realistic. Hence, do your research in terms of the industry standards, the amount of work and the location of your business to determine your salary.
Pay Yourself As a Member of an LLC
You would distribute the profits (or draw) earned during a fiscal year in case you choose to pay yourself as a member of a Multil-Member LLC. Accordingly, each member gets the percentage of their profits as per the operational agreement.
Pay Yourself As an Independent Contractor
You can also work as an independent contractor for your LLC in case you have a specialized skill set that your business demands.
For instance, you can undertake graphic designing work for your business to make designs for your website and clients for your LLC.
Paying yourself as an independent contractor allows your business to stay within the budget.
Accordingly, you will have to pay self-employment taxes on your wages if you hire yourself as an independent contractor.
How Am I Taxed As The Owner Of A Single-Member LLC?
IRS 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 IRS disregards the fact 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 taxes like social security tax and medicare tax.
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.
Therefore, members of an LLC gain from the investment they have made in the form of increased company earnings. That is to say, every member of the LLC has a legal claim on the company’s earnings.
Furthermore, an LLC is a pass-through LLC wherein the company does not pay income tax on its earnings. Rather, the earnings pass through the members of an LLC.
This means that every member of the LLC must mention his or her share of earnings from the LLC on their income tax return and pay personal income taxes on the same.
Accordingly, each member must pay income taxes on the portion of the company’s income they receive during a given tax period.
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.
IRS 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, the IRS considers independent contractors either as sole proprietors or single-member LLCs. This means that independent contractors are recognized as self-employed by the IRS.
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 like social security and medicare taxes, unlike employees.
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
Tax Obligations of a Self-Employed Individual
IRS considers an independent contractor as a self-employed individual. Therefore, the tax obligations of an independent contractor are the same as that of a self-employed individual.
As a self-employed individual, you are required to file an annual tax return and pay estimated tax each quarter.
Typically, self-employed individuals are required to pay Self-Employment Tax (SE Tax) as well as income tax.
Self-Employed tax is nothing but the Social Security and Medicare tax fundamentally for the individuals who work for themselves.
The Self-Employed Tax is similar to the Social Security and Medicare taxes deducted from the pay of wage earners.
However, the self-employed tax does not include any other tax like income tax. It only includes social security and medicare taxes.
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 like S Corp 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, the IRS recognizes 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 the state laws. Hence, you need to go through the state 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.
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.
There two ways in which you can pay yourself:
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.
However, if you are an S corporation, you can pay yourself a salary and take an owner’s draw or dividend.
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 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.
S Corporations are the ones that pass on corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.
This means that the owners of S corporations report their share of profit and loss on the personal tax returns.
Whereas, the C Corporation is a common type of corporation wherein both the company level profits, as well as shareholder dividends, are taxed.
This means the C Corps are subject to double taxation, unlike S Corps. S corporations are pass-through tax entities that are not taxed at the corporate level. Only the shareholders’ income of an S corporation is taxed.
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.
As per IRS, you need to make a reasonable payment to yourself as a business owner.
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, biweekly, semi-monthly, and monthly. Every state has its payroll schedule.
Therefore, you need to check with the department of labor as to under what payroll schedule your state falls.
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 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. Typically, there are five types of business taxes:
The federal income tax is the tax that you pay as you earn or receive income during the year.
The income tax is withheld from your salary if you are an employee. However, you might have to pay an estimated tax in case you do not pay your tax through withholding.
Furthermore, you may pay the tax due when you file your income tax return if you are not required to make estimated tax payments.
As per IRS, you must pay taxes as you earn or receive income during the year. There are two ways in which you can pay income tax: through withholding or estimated tax payment.
You may have to make estimated tax payments in case:
- the amount of income tax withheld from your salary or pension is not sufficient or
- if you receive income such as dividends, interest, self-employment income, capital gains, alumni, prizes, and awards.
Generally, you need to make an estimated tax payment if you work for yourself. Accordingly, individuals including sole proprietors, partners, and S corporations shareholders have to make estimated tax payments.
Provided, the amount of tax they owe is expected to be $1000 or more while filing their income tax returns.
However, corporations have to make estimated tax payments if they expect to owe tax of $500 or more while filing their returns.
Also, the estimated tax is used to pay not only income tax but other taxes like self-employment tax and alternative minimum tax.
Self-employment tax, as the name suggests, is typically for the individuals who work for themselves.
It is social security and a medicare tax that contribute to your coverage under the social security system. Social security coverage provides you with the following benefits:
- Retirement benefits
- Disability benefits
- Survivor benefits
- Hospital insurance (medicare) benefits
You need to pay certain employment taxes in case you have hired employees as a business owner. The following are the employment taxes that you must deposit within the due dates.
- Federal Income tax
- Social Security and Medicare Taxes
- Additional Medicare Tax
- Federal Unemployment (FUTA) Tax
You have to pay excise tax as a business owner if you do any of the following:
- Manufacture or sell certain products
- Operate certain kinds of businesses
- Use various kinds of equipment, facilities, or products
- Receive payments for certain services
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?
IRS recognizes partnerships 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)?
IRS also views an LLC 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 the state laws.
Therefore, as the owner of an LLC, you need to go through the state 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. Watch the following video to understand how you can record the owner’s draw in Quickbooks.
How do I Pay Myself From My LLC?
You can pay yourself from an LLC in the form of salary or the owner’s draw. Salary is the recurring payment that you receive every month, just like an employee. Paying yourself a salary is an ideal option if a certain amount of income is required each month to meet your personal needs. You can also receive the owner’s draw. Remember, if you are a multi-member LLC, you would distribute the profits (or owner’s draw) amongst each member based on the percentages mentioned in the operating agreement.
How do You Pay Yourself as a Business Owner?
How to pay yourself as a business owner depends upon the business structure and payment method. The owners of sole proprietorships, partnerships, and LLCs are considered self-employed. Hence, they receive the owner’s draw and do not pay themselves regular wages. However, the owners of a corporation who are engaged in its day to day operations, need to pay themselves as salary.
What Percentage Should you Pay Yourself from your Business?
There is no standard formula to pay yourself as a business owner. A sole proprietor, partner, or an LLC owner can legally draw as much as he wants for the owner’s equity. However, the amount withdrawn must be reasonable and should consider all aspects of business finance. These include operating expenses, debts, taxes, business savings