How to Pay Yourself as a Small Business Owner
As a business owner, you deserve to get paid for the countless hours you put into making sure your company succeeds. While figuring out how to pay yourself as a business owner can seem daunting, it’s not as hard as you think.
Here are a few ways to pay yourself while taking into account business expenses and taxes, plus tips on how to calculate your owner’s draw or salary.
Ways to pay yourself as a business owner
As a small business owner, you can pay yourself through an owner’s draw, salary or combination method.
- Owner’s draw: This allows business owners to pay themselves without issuing regular paychecks or withholding employment taxes. You can simply write a check to yourself from the business checking account or transfer money from your business account to your personal account on an as-needed basis.
- Salary: This payment goes through a payroll service and is usually made on a regular basis, such as weekly, bi-weekly, or monthly. It’s usually a set amount but may be based on the number of hours worked or other factors. Salaries can range from minimal to six figures depending on the size of the business. When you pay yourself a salary, you cut a paycheck and withhold the applicable income and employment taxes from your compensation.
- Combination method: This method involves having a portion of your income as a base salary while also taking regular or occasional draws as needed.
What is a reasonable salary?
The Internal Revenue Service (IRS) requires corporate shareholders and business owners to pay themselves a reasonable salary for their involvement in the company.
A reasonable business owner salary is what the business would pay an unrelated employee or independent contractor with a similar level of experience for providing the same services within that field.
For example, if you run a dog walking business and pay independent contractors $20 an hour, it might raise a red flag if you pay yourself $500 an hour for the same services.
Owner draw vs. salary: Pros and cons
| Owner’s Draw | Salary | |
|---|---|---|
| Pros | Access to more funds. If profits are up, you can take a larger draw. More flexible. You can withdraw funds as needed rather than waiting for a scheduled paycheck. | More stable. You receive payments in regular intervals rather than as profits come in. Easier tax planning. Taxes are automatically deducted with each paycheck. |
| Cons | Unpredictable income. You may not know how much money you can withdraw until profits come in each month. Not ideal for budgeting. It can be hard to keep up with loan payments, tax bills and other expenses since you don’t know your earnings ahead of time. | Extra paperwork for payroll. Requires withholding and paying employment taxes before determining your take-home salary. Not flexible. You have to stick to a reasonable compensation schedule, even when your business’s revenue drops. |
Other forms of payment
In addition to a salary, shareholders and business owners can also receive dividends or shareholder distributions.
Dividends and distributions are payments made by corporations to shareholders out of profits after taxes have been paid. The company can pay dividends and distributions in cash, in stock or other property.
Note that you can pay yourself with a salary plus dividends as an S-corp, or a salary plus distributions as a C-corp.
Paying yourself by business type
The type of business entity you choose impacts how you pay yourself. The business structures below allow you to have employees as long as you follow your state’s employment regulations and deduct the required taxes from their paycheck.
| Business entity | Definition | Payment method options | Tax form |
|---|---|---|---|
| Sole proprietorship | An unincorporated business with a single owner. | Draw | Schedule C (Form 1040) |
| Partnership | Two or more owners who contribute time, skills, money, property and more to keep the business running. | Draw | Form 1065 |
| Limited Liability Company (LLC) | A business that is separate from its owner(s), helping protect your personal assets and finances. LLCs can be single-member or elect to be taxed like partnerships, S-corps or C-corps. | Draw |
|
| S-corp | A corporation that can have up to 100 shareholders, and business owners are personally taxed on their shares instead of the company being taxed at the corporate level. This allows business owners to avoid double taxation. | Salary and dividends (draws are also allowed, but not in place of a reasonable salary) | Form 1120-S |
| C-corp | A corporation that can have unlimited shareholders. The company pays taxes at the corporate level, and then shareholders pay taxes on their dividends — which results in a double taxation. | Salary and distributions | Form 1120 |
How much should you pay yourself as a business owner?
According to PayScale, U.S. small business owners have an average annual salary of around $70,000. Your take-home pay will depend on your business type, how long you’ve been operating and the company’s financial stability.
Many entrepreneurs don’t take a salary in the early stages of their company or until their business is turning a decent profit. However, paying yourself should be considered a regular operating expense — not just something that should happen once the business takes off. It’s important to consider how your salary will affect other areas of your personal budget, such as housing, retirement and paying your own bills.
Paying yourself with owner’s draw
You need to calculate your business’s net profit before making any withdrawals to ensure you leave enough money in the account to cover operational expenses and taxes. As a general rule, you should save around 30% of your business income for taxes.
Note that your business may be required to make quarterly business tax payments (check with an accountant or business advisor for more details).
You can also withdraw a set percentage of your business’s profit with each draw, adjusting for seasonal fluctuations in revenue.
Paying yourself with a salary
To determine your salary, you need to first estimate your company’s annual gross revenue and subtract all operating costs, such as rent, employees’ salaries, inventory and supplies. Make sure to set aside extra to cover emergency expenses or business debt, such as payments for a small business loan.
From there, divide what’s remaining by 52 weeks and create a payment schedule using a payroll service or an accountant. Just remember you have to follow the IRS’s reasonable salary guidelines, keeping in line with what others would get paid in the same industry.
With the salary method, you don’t have to calculate extra tax payments or save for quarterly payments — the payroll service will do this automatically for you.
4 mistakes to avoid when paying yourself
To help you avoid missteps when paying yourself, here are some of the most common mistakes small business owners make and how to avoid them.
1. Not keeping personal and business finances separate
It’s important to keep your personal and business finances separate, especially when tax season comes around. You need an accurate record of your qualified business deductions in order to claim them on your business tax return.
Some business structures, such as LLCs, require you to maintain the legal separation between you and your business.
Pro tip: To keep your business and personal finances separate, open a business checking account and dedicated business credit card to use only for business expenses. Try to avoid paying personal expenses out of your business account and vice versa.
2. Not planning for taxes
It’s essential to plan for taxes when deciding how to pay yourself.
If you pay yourself a salary, you can automatically withhold income and employment taxes from your paycheck. Using a payroll service or accountant can make this process super easy.
But for those taking an owner’s draw, you may need to save up and make quarterly estimated payments toward income and self-employment taxes.
Pro tip: Work with an accountant or tax professional to figure out your business’s tax rate and how much you should be withholding from your paychecks or draws.
3. Not consistently paying yourself
Paying yourself consistently is essential, as it allows you to stay on top of your personal finances while running your business. Consider your own salary or draw as a regular operating expense — not just something that happens if and when you make a profit.
Falling behind on your personal expenses could negatively impact your business, especially since some lenders review your personal credit score along with your business credit report when approving loan applications.
Pro tip: Create a business budget to better understand your company’s cash flow and to help create a solid payment schedule for yourself.
4. Not accurately tracking expenses
Recording all business income and expenses will help you accurately track the available cash in your business checking account. This will help prevent potential financial mistakes or errors in accounting.
If you find yourself in a pinch, you can consider a business line of credit to help cover seasonal dips in income.
Pro tip: Invest in a business bookkeeping service to stay on top of your company’s cash flow and to avoid your bank account getting depleted.
Frequently asked questions
The best payment method for a small business owner depends on your business’s structure and how often you need funds. For example, sole proprietors and single-member LLCs can only do owner’s draws since they aren’t set up for a payroll structure. However, corporations like S-corps and C-corps can create an annual salary, along with dividends and distributions.
Whichever method you choose, you need to consider your current cash flow as well as projected expenses to ensure you don’t pay yourself too much. Using the right payroll tool can help keep your business on track.
There’s not a one-size-fits-all formula for calculating your take-home pay. You can calculate your owner’s draw or salary percentage rate based on your company’s overhead expenses and cash flow projections, as well as your business’s needs. For example, you might want to set aside extra earnings to cover an expansion or new equipment, therefore taking a little less in your own salary.
If you’re starting a business, you’ll also want to account for startup business expenses, such as registering your business, licenses and permits, insurance and more.
For S-corps and C-corps, your salary and the company’s portion of your FICA tax counts as qualified business deductions. Claiming these expenses can help reduce your company’s total tax bill.
Unfortunately, sole proprietors, partnerships, and single-member LLCs can’t legally pay themselves with W2s and therefore can’t claim any owner’s draws as a business expense. That said, you can claim payments made to other employees or independent contractors — either was W2 salaries or 1099 payments.