Payday — these words can sound like music to your ears. After all, you’ve worked hard in your business, it’s about high time you (literally) got paid!
Even though the days of getting a regular paycheck from an employer feels long gone, it doesn’t have to be. Sure, your business income may be sporadic but you can indeed pay yourself a salary.
All it takes is a little know-how so that you can start making deposits from your business bank account to your personal one. Don’t worry, I’ll show you how so you’re not sitting here, sweating profusely wondering how it’s all going to work.
Determine how much to pay yourself
Wouldn’t it be great if you could pull a number out of thin air and your owner would magically work out?
Instead, picking the right amount of money to pay yourself takes a bit of math and finesse. It has to do with how you can still keep a roof over your head and make sure your business is still going strong for years to come.
Yup, this means you need to think about what your personal expenses are, how much you need to pay in taxes and what your business needs to grow.
To start, be prepared to get really intimate with your net income — if you have a profit and loss statement, that’s a good place to start. Seeing these numbers means you’ll get to take a good look at how much you’re spending on your business and what’s leftover after taxes.
You may have heard elsewhere that there are rules about percentages you need to allot for each part of your business (including your pay). The truth is, the final number you come up with will be as individual as your love of bento box food art (oh, that’s just me?).
What I’m getting at here is that you need to determine a number that best suits your needs. Perhaps you have some business debt payments or investments you want to make — the amount you pay yourself may be less.
The point here is to look at what you really need to spend on your business, then look at any savings goals you may have. Do you want to hire a business coach but their program costs thousands of dollars? Or you want to hire your assistant for more hours? Once you subtract the amount you need for your business, the rest is technically up for grabs.
Of course, you don’t want to pay yourself so little that you can’t pay your electricity bill or put food on the table. So, if the amount you have left over is way too little for you to live on, then it might be time for a business reality check. Do you really need to save that much for your business (perhaps hold off on hiring that virtual assistant)?
It’s great that you want to put your money towards business growth, but there’s nothing wrong with prioritizing your personal needs. To figure out how much you really need, look at your personal expenses and savings goals. What looks like a reasonable number?
Yes, this all sounds complicated, but I assure you that it isn’t. Once you sit down and look at the numbers, determining a number is easier than you think.
Figure out a payment schedule
Here comes the fun part: actually paying yourself!
Once you’ve determined a number (whoo hoo!), you can decide how often to pay yourself. Most employees are paid either two times a month or once every two weeks. But you’re self-employed and it’s up to you whether that works, or you prefer to pay yourself every week or once a month.
As for how you want to pay yourself, it’s up to you. You can write yourself a physical check and then deposit it into your personal bank account or set up a recurring payment via direct deposit. Although there’s nothing wrong with good ol’ cash, the first two options are probably more convenient.
Once you’ve picked how often and your method of payment, go ahead and set up what you need to in order to start receiving money. This could mean logging in your online business bank account and setting up a recurring transfer or ordering paper checks so you won’t be scrambling come payday.
Taking an owner’s draw versus a salary
When you’re paying yourself, you need to be careful about whether you’re doing it as an on owner’s draw or a salary. Figuring out which is the best option for you is important because your pay will be taxed differently depending on the one you choose.
The IRS wants to make sure you’re following the rules and paying taxes properly.
Before we move forward determining the right payment method for you, let’s take a look at the difference between an owner’s draw and a salary:
- Owner’s draw: This method of payment refers to you (the business owner) taking out money from the business for personal use. As in, you’re taking out money to compensate the owner. This can happen as needed or at a regular schedule.
- Salary: You receive a predetermined amount each pay period after determining what a reasonable compensation will be. For example, your business gives you a $3,000 paycheck every two weeks.
Your business tax classification is one of the biggest factors in determining whether you choose between an owner’s draw or salary. That’s because different structures have different rules on how you, the owner may be compensated.
More specifically, if you’re a sole proprietor, single-member LLC not filing an S Corp election, or partnership, you’ll pay yourself through owner’s draws. The IRS considers these types of entities as pass-through entities and the owners cannot be paid , m through regular payroll or wages.
If you go this route, you won’t pay taxes on the amount you draw out. Instead, you’ll pay taxes on your total taxable net profits via your individual tax return. It’s important to keep in mind that regardless of if you keep money in your business or draw it, you’ll be taxed on the total profits.
In other words if your business’s profit is $50,000 and you only take $1,000 in owner’s draws, you’ll pay taxes on the $50,000 not $1,000. ,
For businesses who are classified as an S Corp, you’ll need to pay yourself a reasonable compensation via a salary. The money earned goes to the business, and you’re an employee of that business. That means you’ll need to set up payroll and make regular salary payments to yourself. If you want to pay yourself more throughout the year, you can either increase your salary or take a distribution (which is just another way of saying an owner’s draw).
Review and Refine
Paying yourself when you’re self-employed can be a simple process, but it is far from perfect. Even if you’ve determined the number of your owner’s draw or salary, it’s a good idea to review it regularly (say, once a quarter) to see whether it still works. If it does, great! If not, then it’s back to the drawing board.
At the end of the day your business can help so many people, but you need to help yourself too. If you don’t pay yourself regularly and enough to pay the bills, then you’re risking your personal finances. Taking too much without considering your business’ health will put your company at risk.
It’s a fine balance. But you know you’re a business rockstar, so you’ll get it figured out.
Sarah Li Cain is a finance writer and a candidate for the Accredited Financial Counselor designation whose work has appeared in places like Bankrate, Business Insider, Financial Planning Association, Investopedia, Kiplinger, and Redbook. She’s the host of Beyond The Dollar, where her and her guests have deep and honest conversations about money affects their well-being, and Podcasting Q&A, a branded podcast from Buzzsprout.