How to Pay Yourself as a Business Owner
With great power comes great responsibility. Learn the differences between an owner’s draw vs. salary and the best steps on how to pay yourself as a business owner in this walkthrough.
Owning your own business can be both thrilling and daunting. From determining your business structure to finagling how to pay employees, you’ve got a full plate. An obvious first question most business owners want to answer is how to pay yourself. Keep reading to learn about the factors that go into paying yourself as a business owner and start the path to cutting yourself a paycheck.
You can pay yourself an owner’s draw or a salary as a business owner. The type you choose depends on what you want to get out of your business and what makes the most sense for you and your financial future.
What Is the Owner’s Draw Pay Type?
Owner’s draw means drawing from the money your business makes as needed. For example, you might draw a smaller sum of business profits during months when you’re making food at home and not making any big purchases and a bigger sum when you’re living Gatsby-style. You can take out up to the amount of money you invested in your business; this amount is known as owner’s equity.
What Is the Salary Pay Type?
This payment model for business owners should feel familiar to anyone who has ever earned a steady paycheck. When you pay yourself a salary, it’s the same as when you pay your company employees their wages. Your salary should meet the IRS “reasonable” requirement, which means you should pay yourself a salary equivalent to others in your position and industry—don’t take a salary much higher or lower than what tax experts would find reasonable.
Owner’s Draw vs. Salary
Whether you go with the owner's draw or salary depends on factors including business type, where your business is in terms of growth, and your financial situation.
Business type: How to pay yourself with an LLC differs from how to pay yourself as a corporation. For a sole proprietorship, a partnership, or an LLC, it’s typical to take an owner’s draw. Alternatively, a corporation (whether S-corp or C-corp) or an LLC being taxed as a corporation usually indicates that you’ll take a salary for payment.
Financial situation: You started a business expecting to have cash flow to cover your personal expenses eventually. Consider any debts, obligations, and purchases you hope to make when considering how to pay yourself.
What Are the Pros and Cons of an Owner’s Draw or Salary Payment?
While both options have benefits, you must weigh which fits your financial needs and lifestyle best. If you have fluctuations like seasonal booms, an owner’s draw allows you to pay yourself more during high-earning times and less in leaner months. As your business brings in money, you can adjust as needed. But, of course, it makes it more difficult to plan without consistency. This option also requires extra prep for tax season. Avoid the sinking feeling of not properly budgeting for the bill and face the paperwork upfront.
Salaries offer steady paychecks that allow you to properly budget your personal and business lives. They also include upfront tax deductions, meaning no major surprises and less paperwork at the end of the fiscal year. A steady salary does mean little to no wiggle room, meaning if you have a bad month financially or any unexpected expenses, you are more locked into your set wage.
How Much Should You Pay Yourself?
How much you pay yourself depends on different things for an owner’s draw and a salary.
Owner’s draw: These payments come from a business’s total revenue minus any operational expenses or the net profit. You must pay employees and other obligations before diverting any dollars to yourself. Many business owners paying themselves with an owner’s draw use a percentage of the business’s overall profit. Following this model, you get more dough as your business grows.
Salary: This payment must meet the IRS’s reasonable compensation value. Check their reasonable compensation guidelines to make sure you comply. While there has been much legal debate over what constitutes reasonable, you don’t want to risk the success of your business over discrepancies—especially going up against a stiff contender like the IRS.
To ensure your salary payment meets the reasonable compensation standard, look on salary aggregate sites like ZipRecruiter, Glassdoor, Salary.com, Indeed, and the Bureau of Labor Statistics. You should find continuity in salary level for your line of work and position across the board.
If you run across disparity, try being as specific as possible. For example, a photographer specializing in actor headshots in Los Angeles might have higher reasonable compensation than a photographer specializing in family photos in Gulfport, Mississippi. It’s all about finding what someone in your exact position could expect to be paid by an external employer.
Avoiding payment mistakes: When paying yourself, avoid mixing your business and personal finances. A business credit card and separate business expenses are the best way to skip an accidental mix-up.
Finally, always budget for taxes, especially when using an owner’s draw. Many apps like QuickBooks, Xero, and Bench can help with budgeting for your business—or it never hurts to have a professional accountant on deck.
See other resources related to:
