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Accurately paying yourself as a small business owner is essential. Choose the proper business structure and payment method to see your business thrive.

How to Pay Yourself as a Small Business Owner

Egon Tiderman
March 08, 2020

When you own a small business, you're responsible for your employees getting paid promptly. Running a small business also means having to run more than one department at the same time. One of the aspects of business some owners struggle with is how to pay themselves. What payment method is the best, and what is the right payroll schedule?

The answer is nuanced as there is no one right way to pay yourself when you're in charge. In this article, we'll touch on all the relevant factors to consider when making this decision.

The Difference Between Owner's Draw and Salary

First and foremost, we have to outline the difference between receiving a salary and compensating your work with an owner's draw.

A salary represents a fixed sum the business owner sets for themselves. They abide by a chosen payroll schedule that withholds all the taxes and deductions from the gross pay.

The owner's draw is when a business owner dips into the business account and withdraws a sum for personal use. The owner's sum can have a fixed schedule but not necessarily.

It's pretty standard for small business owners to choose the draw against a salary. It offers more flexibility as the compensation can fluctuate depending on how the business is doing. The downside of the owner's draw is that it can often reduce the business equity and create future problems in terms of spending.

Salaries require less administrative work as all the taxes and deductions are withheld automatically. It also makes tracking income and expenses much more manageable.

The biggest issue with choosing salary as the payment method when you're a business owner is the cash flow. What will you do if sales are down one month? It's possible to give yourself some wiggle room, but every salary needs to be filed with the Internal Revenue Service (IRS.) Setting the gross wage for yourself can also be tricky.

Consider Your Business Structure

The type of business entity you're running will have a significant impact on how you pay yourself and how you pay taxes. There are four major business structures to choose from when you're first setting up your business.

Sole Proprietorship

In a sole proprietorship, you and your business are considered the same entity for legal and financial purposes. It's the most straightforward and least expensive structure to create. The recommended payment method for a sole proprietorship is the owner's draw.

Being a sole proprietor gives you the freedom to receive all the profits. However, that also means you're liable for every loss, and you have no protection for your personal assets. If you end up too far in debt, the courts could seize your personal assets, including your car, home, and savings. 

Partnership

When you and at least one more person own a small business, it means you're in a business partnership. Depending on your portion of the company, the profits and losses will also vary. These matters are typically addressed in a partnership agreement. Same as the sole proprietorship, it's also a relatively inexpensive and straightforward business structure.

Partners are not paid in salary, so the owner's draw is the go-to option. However, they can be paid for services rendered which can be a regular and guaranteed payment. Each partner is then obligated to pay income tax on their guaranteed payments.

Corporation

There are two types of corporations — C corporation and S corporation. In both instances, you're legally separated from your business and protected from any losses. The difference is in how you are taxed. If you run a C corporation, you have to pay individual income taxes and business taxes.

In an S corporation, double taxation doesn't exist. In both types of corporations, the optimal payment method is a salary coupled with dividends. You will have a set income, plus the fair distribution of the company's profits.

Limited Liability Company (LLC)

An LLC can be either single-membered or multi-membered. LLCs are an attractive middle-ground between sole proprietorships and corporations. You get the personal asset protection and tax options of a corporation without the complexity. If you run an LLC, you can essentially choose your preferred tax payment method. 

Other Factors to Consider

If you're running a corporation, you won't have the option to implement an owner's draw. However, in all other business structures, you have a choice, regardless of the recommendations, especially for LLCs. Before opting for one or the other, contemplate the following considerations.

Profits

How much revenue your business generates should be the number one factor in this process. If your business isn't doing that well this month, perhaps cutting yourself a smaller paycheck is prudent.

A large wage doesn't make much sense if you can't cover all the business-related expenses. Having a modest business budget can provide an accurate estimate of how high your salary should be.

Also, consider how long you've been in business. If you're running a startup, don't rush to pay yourself too much.

Determining Your Value

Determining your dollar value to the organization is something many small business owners struggle with. It's your business, and you likely spend every waking hour making it work and trying to turn a profit. If you spend 12 hours per day in the office, you deserve to be paid more than the employee who is there eight hours per day. 

If that's still not enough to make the decision, perhaps take a look at your competitors and ask around about payment averages.

Personal Expenses

In the same way overpaying yourself as the business owner can backfire, so can underpaying. You must have enough to cover all personal expenses. It's the only way you genuinely see the business grow.

Ensure all recurring expenses are covered and that items such as loans, gas, and food are all in order. When possible, consider creating a safety net, no matter how small.

It's a Delicate Balance

To be a successful business owner, you need to have a passion for what you do. While making a profit is a part of the deal, it's typically not the only motivation.

Having an idea and seeing it grow can be inspiring. Unfortunately, it can lead to making wrong decisions on how much you're paying yourself. Overestimating your role in the company can be equally detrimental as underestimating it.

The first step is to choose the preferred type of payment and make it work for you. When it's just you and no partners and no shareholders, then you only have yourself to report to. Whatever you choose to do, don't forget to pay yourself enough to cover basic expenses and pay taxes.

Small business owners wear a lot of hats. If you're spending too much time on payroll and not enough time running the actual business, consider a pay stub generator. Paystub Engine is happy to help you create pay stubs for you and your employees, freeing up your time and attention for more important matters.

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