How To Pay Yourself as a Business Owner
Signing your own paycheck is the ultimate ‘NOBOSS move’!
LOL, seriously, pat yourself on the back for being in such an accomplished position.
OK, that's the fun side of things. On the business side of things, at some point, you need to decide how to pay yourself.
As an accountant and entrepreneur, I get asked this question often. But I am most surprised that new entrepreneurs feel indifferent about paying themselves. OMG, isn’t that why you started your business in the first place?
So, before we go any further let me put your mind at ease. Yes, it is perfectly legal to pay yourself from the business that you own. However, the method for paying yourself depends on the legal business structure. You’ve worked hard to build your business to get to this point. And, just as any hard-working person deserves a paycheck, so do you.
So, listen up because I'm going to show you the correct ways to pay yourself from your business so that you can:
Minimize taxes.
Eliminate errors.
Reduce the likelihood of an audit.
Be compliant.
And, distribute accurately and fairly to Partners.
Let's get started!
In the financial world, there's a certain way to do things. When it comes to owners getting paid, there are three proper ways to accomplish this.
Owners Draw
Payroll Check
Distribution of Profits
Your options largely depend on the type of legal business structure you own. So, let's break them down.
OWNERS’ DRAW
Owner’s Draw is an account that appears on your financial statements, specifically your balance sheet. It is 1 of 2 accounts that total business Capital.
Owners’ Equity represents the amount owned by the Owner or each partner of the business. The offset to this account is the Owners’ Draw, which represents the amount taken or paid to the Owner or each Partner.
In a sole proprietorship or partnership, you are not employees of the business you ARE the business. In most cases, sole proprietors and partners are not allowed to be on the payroll. However, check the facts in your state.
For certain you can take a draw from the business as a Sole Proprietor or Single-member LLC, you simply write a check or transfer money from the business to your personal bank account. Show that amount that you’ve transferred as an Owners’ Draw in your bookkeeping software. Also, don’t forget to estimate and set aside money for the taxes you may owe on each Draw.
PAYROLL CHECK
Your next option is to take a payroll check. However, this depends on the type of legal structure that you have. Remember, sole proprietors cannot take a payroll check but as a corporation, you can!
If your business is a corporation or an LLC taxed as a corporation, and you work in the business you can pay yourself a salary with taxes withheld.
If your business is a C Corp, S Corp, or LLC you are legally required to pay yourself a regular salary with payroll taxes. LLCs can file Form 2553 with the IRS to be treated as an S Corporation for tax purposes. This often allows LLCs to pay lower self-employment taxes. One requirement for using this tax classification is that any owners must be treated as employees and paid through a payroll service.
HOW MUCH SHOULD YOU PAY YOURSELF?
You'll quickly learn that most business decisions will be based on financial information. Decisions like when to hire new employees, your marketing budget, and of course, how much to pay yourself, all come down to what the business can afford.
To determine how much to pay yourself, start by looking at the numbers:
How much revenue was coming in?
How much is going out in expenses?
How much cash do you have left over?
From the remaining “leftover” amount, how much can the business afford to pay you? This is your monthly salary, which will be dived by the pay periods per month.
Will this amount cover your personal expenses?
Ideally, you want to look at monthly sales for a full 12 months. This will clearly show you what times of year are peak sales months and which months are slow sales. This is important because you don't want to overstate what the business can afford to pay, and find payroll difficult to meet during the slow sales months.
Make a final decision on the monthly amount but, don't take the wages just yet! Watch your finances, sales, and cash flow over the next pay period or two to prove to yourself that you can afford to pay the amount without causing financial stress to the business.
PROCESSING PAYROLL
There are two obvious choices to process business payroll: outsourcing or in-house. Which will be best for you?
Outsourcing – Payroll, or any other service, is a matter of having another business handle tasks that you may normally handle or have the option to handle. Depending on what tasks you're outsourcing, it can be a time saver and cheaper than hiring an employee to do it in-house.
When it comes to payroll there is no room for error. Review the many payroll processing services and find the best deal and the best service for you.
NOTE: For each pay period, you will need to enter gross payroll, net payroll, payroll deductions, and employer payroll tax amounts into your bookkeeping accounting system. This is a must! Otherwise, your financial statements will not be accurate in representing payroll expenses and profit or loss for the month.
In-House - processing your payroll in-house is not difficult, it's a matter of accuracy. To reduce errors and eliminate potential catastrophes:
Hire an experienced Payroll processor (Clerk, Specialist, Administrator)
Hire someone with experience to train you to process the payroll.
Cross-train a second person in the event of an emergency. (Partner, spouse)
Automate payroll using accounting software like QuickBooks or Sage Peachtree.
NOBOSS offers a Bookkeeping service, which includes software training, assistance in hiring a qualified bookkeeper, accounting software implementation, data cleanup, and accounting management. Schedule a consultation to get started.
DISTRIBUTION OF PROFITS
Distributions are made to business owners by taking cash out of the business from retained profits or cash that investors put into the business. An LLC's profits must be allocated among its members every year. The allocation of profit is NOT the same as the actual distribution of profit. The LLC Owner(s) has a choice of when to take distributions.
If you are a multi-member LLC taxed as a partnership you can move money to each of the partners’ personal accounts based on the profit-sharing rules or guidelines within your operating agreement. For example, if you have four partners each owning 25% of the business you would transfer 25% of the profits to each partner. Show the transferred amount as “Partner Name, Owners’ Draw” in your accounting software.
The percentage each Partner owns is not necessarily divided evenly. This percentage of ownership is based on how much each Partner contributed to the startup capital. Partner contribution may be in cash, assets like equipment, or experience to create the product. Once Partner contributions are determined, an agreement is created to identify the percentage of the business each Partner owns. This percentage is used to transfer both loss and profits.
The STARTUP BUDGET – Capital TAB, accurately documents each partner's contribution.
If you are a corporation or an LLC taxed as a corporation you don't have to take all your compensation in salary, you can also take a draw or distribution as well.
If you are an S-Corporation all business profits flow through the personal tax returns to the owners. Some S-Corporation owners see tax savings by limiting their salary and taking the rest of their pay as distribution.
Well done! You're on your way to even more success. You're doing something right so keep going.
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VISIT US -This information is part of the Should You Incorporate series. For more information about Legal Biz Structures, How Taxation Works, How to Pay Yourself, Starting a Business, or NOBOSS tools and resources for entrepreneurs, please visit our website at www.noboss.business
