How to Pay Yourself as a Business Owner: Full Guide

Knowing how to pay yourself as a business owner without draining your funds or overspending your budget is one of the key steps to boosting your profits and investments.

While earning money as a self-employed individual or successfully running your own business can be rewarding, managing your hard-earned income is more challenging than it seems.

Part of the challenge is striking the perfect balance between rewarding yourself and keeping a close eye on your sales and profits to make way for opportunities to grow your business.

So, keep reading to learn the proper way to pay yourself a salary while owning a business!

Key Takeaways

• As a business owner, you can pay yourself by following a fixed salary structure or withdrawing any amount as needed through the owner’s draw method.
• A salary-based compensation for business owners helps keep your business expenses organized and well-managed. The owner’s draw method is more flexible but difficult to document.
• Some common mistakes business owners make when compensating themselves include not considering taxes, mixing personal and business costs, failing to reinvest in the company, and disorganized bookkeeping.

How to Pay Yourself as a Business Owner: Salary vs. Owner’s Draw

If you want to know how to pay yourself as a business owner, there are two ways—pay yourself a salary or get what experts call an owner’s draw.

Salary

When you pay yourself a salary as a business owner, you are essentially getting paid like you would disburse wages and salaries to your employees. That said, you must use a payroll service and follow a fixed pay schedule to monitor your payments consistently.

You must also withhold a percentage of your income to pay all the taxes that apply to your business type.

Owner’s Draw

In comparison, an owner’s draw means getting paid as a business owner without the need to release a paycheck or follow a fixed pay schedule or cycle.

You can withdraw money for your business earnings as needed by transferring funds from your business account to your personal account or by writing yourself a check.

At the same time, you don’t have to pay taxes upfront from your owner’s draw.

Sole proprietors and business owners in a partnership best suit an owner’s draw because of their straightforward setup.

But if you own a corporation or if your LLC is taxed as one, then your best option is to pay yourself a salary because it is easier to apply the applicable tax implications and incorporate them into your business accruals.

Pros and Cons of Salary

There are pros and cons to paying yourself as a business owner in the form of a salary. Let’s discuss each advantage and setback briefly:

Pros

• Structure and organization. Since you follow a specific payroll cycle as you would when paying employees’ salaries, it is easier to keep track of your payments and include your salary in budgeting and planning your business costs.

• Easier tax regulation. An integral part of preparing your and your employees’ salaries is allotting a percentage of your income to pay taxes. If you pay yourself as a business owner in the form of a salary, you must ensure you adhere to IRS tax rules.

Cons

• Rigid process. Salary payments are not as flexible and easy to adjust depending on your business’s financial health. In other words, you must continue adhering to your pay schedule while accounting for your salary and taxes, even when sales drop drastically.

• Additional paperwork. Preparing salaries and taxes entails extensive paperwork, which might lead to hiring additional staff to keep your payroll in check.

Pros and Cons of Owner’s Draw

Now that you know the pros and cons of using a salary structure to pay yourself as a business owner, let’s see the benefits and disadvantages of an owner’s draw:

Pros

• Flexible structure. Since an owner’s draw does not require a specific salary structure, you can withdraw any amount as you see fit. You don’t need to get the same amount through and through and make instant adjustments based on your company’s situation.

• Yields higher income. By using an owner’s draw to pay yourself as a business owner, you can get a higher amount for your payment, especially when profits and revenue significantly increase.

Cons

• Requires higher profit. The owner’s draw method is unsuitable for startups or businesses with a relatively small profit. You will need to earn a higher income threshold to withdraw money from your earnings without following a fixed salary or pay structure.

• Difficult to manage. Unlike salary payments, an owner’s draw does not follow any structure or plan, making it challenging to incorporate it into budgeting for other essential expenses to keep your business afloat.

How Much Should You Pay Yourself?

You might be wondering, ‘How do I pay myself as a business owner?’

When determining compensation as a business or company owner, the rule of thumb is to pay a modest amount and consider your profits, business size, and taxes. Small business owners typically allot 50% of their company’s profit to their salaries, while the other 50% is divided into regular business expenses and taxes.

But, this will all still depend on your business expenses or startup costs.

If you are still in the early stages of developing and growing your business, you may need to get a smaller percentage of your business earnings for compensation. Setting aside 30% of your profit for taxes is also highly recommended.

Once you have combined and subtracted your necessary expenses from your business earnings, you can base your compensation on your net profit.

How to Pay Yourself as a Business Owner: 5-Step Guide

Here is a five-step guide that you can follow if you want to pay yourself as a business owner while following a reasonable rate:

#1. Determine Your Business Type

Your business type determines the amount you can take home as your compensation. For instance, you are subject to double taxation if you own a corporation.

That means you must pay the taxes based on your company’s earnings and then process the taxes owed by your shareholders. Meanwhile, sole proprietors qualify for pass-through taxation since the business owner and the business are considered a single entity by the IRS.

The more taxes you owe, the less salary or income you may withdraw from your net profit. Also, if you own a startup, it would be best to compensate yourself modestly.

#2. Decide on the Payment Method

After determining all the essential expenses and tax implications for your business structure, you can choose the most suitable payment method to pay yourself as a business owner.

Take note of the advantages and setbacks we discussed briefly earlier, and assess whether you have the resources and workforce to meet the demands of earning a fixed salary.

#3. Identify the Amount

Identifying a specific amount to pay yourself is highly recommended, regardless of whether you choose the salary or owner’s draw structure.

In this manner, you have a base salary that you can easily adjust depending on your finances and business needs.

#4. Choose the Payroll Schedule

Like determining a specific amount to pay yourself as a business owner, following a fixed payroll schedule enables you to track your earnings and expenses better.

Withdrawing earnings from your business’s net profit differs from taking money from your personal account. You need to document all transactions tied to your company to ensure your accounting books remain accurate and up-to-date.

Following a payroll schedule, you can quickly review and backtrack all your expenditures and the salaries you have taken out of your profits in the previous months or quarters.

#5. Get Paid

Once you have completed all four steps described above, you can get compensated. Here’s a pro tip: Use online tools like a pay stub generator to manage your earnings and profits more quickly.

Pay stub generators let you easily document your scheduled salaries and even create pay stubs for previous payroll schedules whenever you need to audit your business costs for the year.

5 Common Mistakes to Avoid When Paying Yourself as a Business Owner

Learning how to pay yourself as a business owner also requires identifying some of the most common mistakes to avoid risking all of your business revenue and funds. Here are five of the usual mistakes to keep an eye out for:

#1. Not Budgeting in for Taxes

Avoid disregarding your tax responsibilities when paying yourself as a business owner.

You must set aside a portion of your earnings to pay all taxes imposed on your business. Unlike employees, business owners must pay five different types of taxes, namely:

• Income tax. Unless your business is part of a partnership, you must file your annual income tax return. Income taxes are pay-as-you-go taxes, meaning you must pay federal taxes as your business generates revenue within the year.

• Employment tax. Employment taxes apply when you hire employees or workers. This type of tax is the amount you withhold from your workers’ salaries and wages to pay their federal, FUTA, Medicare, and Social Security taxes.

• Self-employment tax. Self-employment tax includes Social Security and Medicare taxes. If you earn money through freelancing or are self-employed,you are likely to pay self-employment tax.

• Estimated tax. Sole proprietors, S-corporations, and partnerships usually pay estimated taxes or an approximation of the total income or self-employment taxes they owe. This usually applies when they earn different types of income or if the portion they withhold from their earnings to pay their taxes does not suffice.

• Excise tax. Excise taxes are levied on alcohol, tobacco, fuel, airline tickets, tires, and heavy trucks. Businesses selling any of the said goods must pay this type of tax.

By including your tax responsibilities in your monthly or quarterly budget plan, you avoid instances of missing tax deadlines or underpaying your tax dues.

#2. Mixing Personal and Business Expenses

You must set a clear boundary to separate your personal expenses from your business or operational costs to avoid ending up facing bankruptcy before even realizing it.

Mixing the money you spend for your personal and business needs makes it difficult to document and regulate your expenses. This becomes a problem when you have loans, need to pay suppliers, request equipment, or review your profits and losses.

Creating separate bank accounts for your business expenses and personal expenditures is best. This will keep your financial records organized, and you can allot the correct amounts to pay your employees, purchase additional equipment, and settle your taxes.

#3. Inconsistently Paying Yourself

When you pay yourself as a business owner, do you tend to overpay yourself on good days and then reduce your salary depending on the number of sales?

Allotting inconsistent amounts to your earnings affects how you plan your future expenses and align your earnings with your long-term business goals.

While it is okay to reward yourself from time to time for a job well done, having a fixed or set amount that goes into your business owner salary limits how you can adjust your payments accordingly.

#4. Disorganized Bookkeeping

The lack of a systematic bookkeeping process is a typical error when new business owners pay themselves. Whether you run a startup or a mid-sized business, you can hire a bookkeeping assistant or use bookkeeping software to keep track of your sales and expenses.

Better yet, take some time to enrich your accounting and bookkeeping knowledge so you can understand how to maximize your profits and adequately equip your business in case of any significant changes in the market or economy.

#5. Not Reinvesting in Your Business

Reinvesting in your business means setting aside funds to improve your operations. You can do this by purchasing new equipment, providing additional training for your staff, or improving your employee benefits and office facilities.

Investing a percentage of your earnings to gradually enhance your business operations and help your employees improve their skills and expertise brings more fruitful returns to your company.

Remember, you cannot achieve consistent and long-term success with only one aspect of your business undergoing the necessary changes and upgrades.

Track Your Business Income Better With Paystub.org!

The most efficient way to pay yourself as a business owner is to have a reliable system to monitor and balance your earnings and expenses consistently.

Paystub.org can help achieve that through our easy-to-use pay stub generator. It takes three steps to use our generator:

1. Choose from our selection of pay stub templates.
2. Fill in the blank fields with the required information, including your personal and business information, pay details, and taxes. You can also use our built-in calculator to determine your gross and net earnings more precisely.
3. Preview your pay stub, and then print or download a PDF copy.

Final Thoughts

All in all, understanding how to pay yourself as a business owner reasonably and in an organized manner depends on whether you own a small business or a large enterprise.

Essentially, determining your business owner income comes last.

Prioritizing your compensation over other crucial factors that affect your operations may lead to penalties, legal action, and significant financial losses due to unpaid taxes, employees, and mismanaged business funds.

Indeed, you deserve to reward yourself for your hard work, but don’t forget the responsibilities and expectations of running a profitable business venture!