A primary challenge for every small business is to generate sufficient revenue and profit to sustain and grow the business. A secondary challenge is determining how to pay yourself as a small business owner, because no small business owner likely started their business just to work for free.
Why Determine How to Pay Yourself as a Small Business Owner?
Small business owners need to pay themselves to cover personal living expenses and provide financial security. Owner compensation can motivate business owners and help improve their focus and productivity. Including owner compensation in the business’s expenses provides a more accurate picture of the business’s true profitability and valuation.
How to Pay Yourself as a Small Business Owner: Three Ways
Business owners can pay themselves through a draw, a salary, or a distribution. A draw is a direct payment from the business to the owner for his/her personal use. A draw can be regularly scheduled or can take place as needed. A salary is a set wage or amount of compensation for the owner. It requires going through a payroll process where taxes are withheld. A distribution is a payment of profits from the business.
An owner’s draw can be used to withdraw funds at a time that benefits them (and in whatever amount is needed) and when it fits the business’s condition. Because the timing is flexible, a draw can take some pressure off cash flow during slow revenue periods. However, a draw can make tax calculations more difficult and budgeting more complicated because of inconsistent payments. Additionally, using an owner’s draw will reduce the business’s equity, since assets are removed with each draw. And a draw could affect a business’s ability to secure equity financing.
A salary is a more stable form of compensation, thus making planning and budgeting more predictable for both personal and business purposes. Taxes are withheld from salary, making it easier to deal with taxes at year-end. Depending on the business structure, the owner’s salary may be considered tax-deductible.
A distribution can be a flexible payout of an enterprise’s profits.
A determination of how to pay yourself as a small business owner depends on the legal business structure. The choice of owner draw vs. salary needs to be considered carefully.
Business Structures and How to Pay Yourself as a Small Business Owner
Here’s how to pay yourself as a small business owner depending on your business’s structure:
- Sole proprietorship. As a sole proprietor, you can take a draw from your business earnings.
- Partnerships. Partners can pay themselves by sharing the profits generated by the business, taken as an agreed-upon distribution.
- Corporation. For C-Corp and S-Corp owner compensation, an owner can take a regular salary, receiving a paycheck with taxes deducted from the salary. A business structured as a C or S-Corp can only provide a salary to an owner.
There are also tax implications for each business structure. It is important to work with a tax professional to determine the most compliant and tax-efficient way to pay yourself.
Seek Professional Accounting Assistance
Contact Orcutt & Company, based in Milford, OH. We deliver comprehensive financial management for small business owners and individuals, providing strategic solutions that best address client needs and aspirations. Our comprehensive accounting services, including bookkeeping, payroll, and tax, keep you organized and give you the data you need to make prudent business decisions.
