How Should Small Business Owners Pay Themselves

As a small business owner, you have a choice on how you pay yourself. You can take a salary like any other job, you can draw a draw from the business like you are your own supplier, or you can reap the benefits of the business by paying yourself in perks.

Many small business owners choose to pay themselves a salary from the business. This can be influenced by many things, but most commonly it is because they want to earn an income comparable to what they would earn at another job.

Drawing from the business means that you essentially take what you need from the profits of the business to pay for things like bills and living expenses. You do not take a set salary, meaning there is no guaranteed income.

Retaining perks means that you keep all of the benefits of the business for yourself. This can be dangerous because it puts your self-interest ahead of the interest of the business.

Pay yourself a salary

how should small business owners pay themselves

A common method of paying yourself is to pay yourself a salary. This can be tricky for small business owners because there is no ceiling on how much you can pay yourself.

You are the boss, so you set the rules. If you have a company structure where you are the sole shareholder, you can take as much of the profit as you desire. There is no limit to how much you should pay yourself, but that can be a bad thing.

Limit Yourself

It is best to have some kind of limit on how much you take out. You want to reward yourself for the work you are doing, but if there is no limit, then your business could go under very quickly. Withdrawing limited amounts of money keeps the business afloat longer due to less expenditure.

Pay yourself a dividends

how should small business owners pay themselves

A common way to pay yourself as a small business owner is to pay yourself dividends. A dividend is a distribution of part of the company’s net income, determined by the board of directors.

You are the board of directors for your company, so you can decide to pay yourself in dividends. You can even decide to dividend out part or all of the profits your company makes.

Dividends are paid to shareholders on a regular basis, typically every quarter or year. You can choose to receive cash or other assets as a dividend, depending on what your company produces and has available.

There are legal requirements for how large a dividend payment must be. If you take too much money out of the business for personal use, then you may be taxed on it. Make sure you consult a tax professional about this topic.

Buy company stock

how should small business owners pay themselves

Another way to pay yourself is to buy company stock. You can either buy stock at market value or purchase stock directly from the company at a discount.

If you choose to buy stock at market value, you are paying yourself the current value of the company. If the company does well, you reap the benefits along with other shareholders.

If you purchase stock directly from the company at a discount, you are essentially paying yourself less than what the stock is worth. If the company does well, you again reap the benefits alone.

This method is good if you believe in the long-term success of the company and want to hold onto the stock for a while. Buying stocks at a discount can also help curb spending and prevent excessive self-paying.

Make up the difference with cash reserves

how should small business owners pay themselves

As a small business owner, you are your own paymaster. You decide how much you earn and when you earn it. This can be a good thing, but it can also be a bad thing.

You are not dependent on an organization paying you. You have control over your income, which can be an extremely powerful motivator.

But if you do not manage your business finances well, you may find yourself with no income at all. Or if you do not set up the right systems, you could end up spending all of your earnings.

There are two primary ways that small business owners pay themselves. The first is by setting up a defined compensation plan. The second is by putting money into an asset allocation plan that pays them later on.

Understand the tax implications

how should small business owners pay themselves

As a small business owner, you will likely receive compensation for your work. How you pay yourself can have big tax implications.

If you pay yourself a salary, you will be taxed at the same rate as any other income. For example, if you earn $50,000 in business income, you will be taxed at the 2018 federal tax rate of 22% on the $50,000.

If you choose to take distributions from the business’s profits instead of a salary, these distributions are treated as self-employment income. This means that the entire amount is taxable and that you are responsible for paying Social Security and Medicare taxes based on this income.

These taxes add up to about 15% of the self-employment income. Due to the high taxation of this type of income, it may make sense to take a lower salary and distribute the profits as dividends instead.

Talk to your accountant about options

how should small business owners pay themselves

As a small business owner, you have the option to take money out of the business for yourself. This is called a draw. Draws are typically done on a weekly or monthly basis, and are calculated by taking the total business revenue for that period and dividing by the number of pay periods.

Your accountant can help you set up draws so that you are not taking too much out of the business. They can also help you with your taxes by tracking your draws and what income tax you owe on them.

Draws are a great way to pay yourself as well as reward yourself for all of your hard work. When done correctly, draws help keep your business financially stable which prevents no pay periods.

Review annually

how should small business owners pay themselves

Once you have decided how much you are going to pay yourself, you need to issue the compensation annually. You should not defer paying yourself until a later date unless there is a good reason to do so.

You should also review your salary annually to make sure it is still appropriate. For example, if you invested in some new software that helped your business grow, you may want to raise your salary to reward yourself for the hard work.

It is important to remember that when you pay yourself, you are taking money out of the business. If you pay yourself too much, then there will not be enough money left over to invest in new equipment or hire new help.

Carefully consider what an appropriate salary is and how much of a raise you deserve.

Keep your business healthy

how should small business owners pay themselves

When it comes to paying yourself, your business’s health is important. If you take out too much money, the business will not be able to sustain itself.

If you take out too much money for yourself, the business will suffer because you will not be reinvesting in it. For instance, if you did not get a salary increase, you would not be able to invest in more equipment or materials to improve your services.

With limited funds, the business would suffer and possibly go out of operation. This is why it is important to keep a balance between taking a salary and investing in the business.

There are several ways to manage paying yourself as an entrepreneur. The first is to create a budget for yourself each month and stick to it. Paying yourself on time with set amounts will keep the flow of money into the business consistent.

About The Author

Tiara Ogabang
Tiara Joan Ogabang is a talented content writer and marketing expert, currently working for the innovative company juice.ai. With a passion for writing and a keen eye for detail, Tiara has quickly become an integral part of the team, helping to drive engagement and build brand awareness through her creative and engaging content.
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