This is the seventh post in our "Starting a Business Series". This series stemmed from a conversation I had a bit ago with a brand new business owner. They were completely lost and no idea where to start.

That got me thinking that we should do a series on this specific topic so I ran it past everyone in our Free Facebook Group and with overwhelming support, everyone wanted it. So here we are!

When I talk about that conversation I had with that new business owner, this was actually the second question they asked. For that reason I knew it had to be a topic I spent some time on.

How Do I Pay Myself As A Business Owner?

When you are looking to take money out of your business, it can actually be rather simple. Your entity type will help to determine how you will actually pay yourself but first I wanted to list out some possible options. Then I will go through where they fit into your entity type.

• Owner Draw or Distribution
  • This is simply the act of transferring money from the business bank account to your personal account. Or writing a check, taking cash out, etc. Simply put it is just taking business funds and moving them to you personally.
• Payroll
  • As we talked about a few episodes ago, we recommend doing payroll through an actual software. The act of payroll requires payroll tax withholding, tax form filing, and payments to various government agencies. Payroll software can simplify that.
• Guaranteed Payment 
  • These are usually part of a partnership agreement and are a payment that is agreed upon that is guaranteed to a specific partner regardless of profit or loss of the business.
• Dividend
  • These are more rare and work similar to an owners draw or distribution but often times require some extra year-end paperwork.

Based On My Entity Type, How Should I Pay Myself?

• Sole Proprietor or Single Member LLC 
  • You would pay yourself via an owners draw. You are actually not allowed, by law, to pay yourself via payroll.
• Partnership
  • You would pay yourself via an owners draw and/or guaranteed payment. Here again, you are not allowed, by law, to pay yourself via payroll.
• S Corporation
  • You would pay yourself by BOTH a distribution and payroll. Remember when we talk about the advantages of S Corps we mention that you are required to take a reasonable salary but that only makes up part of your income, the rest of it comes in the form of distributions.
• C Corporation
  • You would pay yourself via a dividend and likely a salary.

How Are Taxes Handled In Each of the Payment Options?   

• Owner Draw or Distribution
  • I’m going to get a little geeky, people often get misunderstood on these. An owner draw or distribution is not taxed directly, so if you transfer $50k from the business to your personal, you’ll receive $50k, no taxes need to be taken out on the transfer. However, these are also not expenses to the busineses and thus you will end up paying taxes on it at some point when you recognize the higher income from the business. Here’s a quick simplified example:
    • Starting Bank Balance: $0
    • Profit: $85,0000
    • Distribution to You: $50,000
    • Ending Bank Balance: $35,000
  • In this example you only had $35,000 left in your business bank account however you still would have profit of $85,000 because the $50,000 draw or distribution you took was not an expense to the business. Now when you go to file your taxes at year-end you’ll be paying taxes on $85,000, the profit of the business. In other words you still technically pay taxes on draws or distributions they just do not need to be withheld when making the actual payment to the owner. This is where estimated taxes become so important.
• Payroll 
  • This is a business expense so unlike draws or distributions, it does reduce your business income. However since it is payroll it will turn into new taxable income to you in the form of W2 income.
  • If you are using a payroll software you would have filled out a W4 when you first onboarded as an employee of your own business. That W4 tells the payroll software how much in taxes to withhold from your payment. This means then when you process the salary via payroll you’ll have a gross amount which is the pre-tax amount you earned but you’ll only receive the net amount which is after taxes have been taken out which the payroll company will take care of sending to the respective agencies.
• Guaranteed Payments
  • These are a combination between draws and payroll. With a guaranteed payment it is an expense to the business, however the partner that received the guaranteed payment gets it added back to their income where they will eventually pay taxes on it. Guaranteed payments work similar to draws where there is no tax withhold when making the payment to the partner and estimated taxes are often highly recommended.
• Dividends
  • These are less common for your typical small business owner and get taxed at different rates depending on if it is a qualified or nonqualified dividend.

What Else Do I Need To Know About Paying Myself?

• First things first the most common types of small business owners we see are Sole Props/Single Member LLCs or S Corps which means you would only need to worry about draws and/or salary.
• Taking an owners draw is actually very simple, do not over complicate it. Simply take money from your business bank account and put it in your personal account.
• If you need money personally, ALWAYS transfer it first to your personal account and then spend it. Do not start paying for personal items out of your business bank account.
• Remember: If you operate as a Sole Proprietor, Single Member LLC, or Partnership you are not legally allowed to pay yourself, as an owner, via payroll.

Hopefully this was helpful and now you have no problem getting paid for this hard earned work you are putting in on this entrepreneurial journey!

Finally, I highly recommend you sign-up for our Tax Minimization Program (w/ Stress-Free Bookkeeping Training) as not only will you get a bunch of in depth training, templates, group coaching but you also have unlimited access to our team for general tax and accounting questions. How sweet would it be to have an accounting professional by your side for those questions that pop up in this crazy journey of being a business owner?