How to Pay Yourself as a Small Business Owner

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.

While this all sounds relatively straightforward, you'll need to figure out how to do it, which can be a bigger task than expected.

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, but if you have a partnership, you'll 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 so everyone gets a piece of the profits and losses.

How Do I Pay Myself From My LLC?

A Limited Liability Company (LLC) is a business structure where the owners, also known as the members, are not personally liable for the company’s debts or liabilities. There are multiple types of LLCs, including single member LLCs and multi-member LLCs.

The company is instead considered a seperate legal entity from it's owners, meaning it's the company that pays the taxes. For tax purposes, an LLC may also be classified as a partnership, a corporation, or disregarded entity.

Some countries may not consider the members of an LLC to be employees, meaning the members do not take a salary.

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

A single-member LLC is considered to be a disregarded entity, similar to a sole proprietorship, meaning a single person owns the business and is not taxed separately.

A disregarded entity is not required to file its tax return, instead the business owner reveals their business profits on their own return. It is important to note that while a single-member LLC is still seperate from its owner, legally speaking, the LLC's profits will pass through 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.

Each state has its own tax-filing requirements for LLCs, so you'll need to go through your state’s rules to ensure that all tax-filing requirements are met.

Besides being classed as a disregarded entity, you can have your LLC be classed as a corporation. As such, 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 represent your LLC to be a corporation may lead to a reduction in self-employment, but it may lead to other tax consequences and increased paperwork.

Receive Distributions From LLC Profits

Members of LLCs 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, not as an employee of the entity but as one who provides services independently.

Typically, an individual is considered to be an independent contractor when the recipient of services, or the payer, controls or directs only the result of the work, and does not provide guidance on what work needs to be done or how work is completed.

Some countries may consider professionals providing independent services, like doctors or lawyers, independent contractors. They may also consider independent contractors to be either sole proprietors or single-member LLCs.

This means that independent contractors are recognised as self-employed, so you wouldn't receive a salary as an employee, instead you'd set rates and payment schedules.

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 LLC for personal use.

However, corporations cannot take the owner’s draw, instead taking profits in the form of distributions or dividends. These distributions are based on the percentage of ‌ownership an individual has in the company. The distributions are expenses deducted from corporate earnings, and as a business owner, you'll need to pay taxes on such earnings via your income tax return.

An owner’s draw is the way an owner pays themself rather than taking a salary from the business. These funds must be taken out of the business' profits after paying all the business expenses, meaning the owner’s draw is not a salary, and is instead 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, and 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, so 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 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. The taxation systems in some countries will recognise 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.

This means, each partner includes their share of income in their income tax return, and they’re required to pay income tax and self-employment taxes quarterly.

The rules about the owner’s draw in the case of an LLC vary depending upon laws. You'll 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.

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 a few things to keep in mind when you're making this decision:

Business Structure

The structure of your business is one of the main factors that will help in determining your payroll process, and will indicate what payment style is relevant for your business.

The owners of sole proprietorships, partnerships, and LLCs are considered self-employed, meaning they pay themselves through the owner’s draw for personal expenses rather than regular wages. However, you'll 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, and you cannot deduct the owner’s draw as a business expense, unlike a salary.

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

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, which state and Federal governments will tax.

You'll 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, after you have determined the appropriate payment method, is to calculate the amount you'll need to pay yourself. Generally, this pay will be an 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

To determine how much you should pay yourself, you'll 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, like rent, salaries or business supplies, ‌have been deducted.

Schedule of Payment

You'll also need to think about your payroll schedule, especially if you are the only one running the business.

There are various ways in which you can pay yourself, including weekly, fortnightly, semi-monthly and monthly.

Every state has its payroll schedule, so you'll need to check with the department of labour as to under what payroll schedule falls.

Get Paid

Once you have decided your payroll schedule, you can then pay yourself by either writing a check and depositing the same into your bank account, or by transferring funds directly into your bank account.

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

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, it's important to consider all the aspects of your business finances, including operating expenses, debts, taxes, and business savings, when determining your pay. For this, you would first have to look into the net income of your business, which 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, taking into account:

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

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.

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, meaning 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, but 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