As a business owner, determining how to compensate yourself is crucial. The method varies based on your business structure and tax implications.
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Owner’s Draw vs. Salary
Depending on your business type, you can use an owner’s draw or salary. An owner’s draw is common for sole proprietorships and partnerships, while a salary is typical for S corporations.
Key Considerations
When deciding, consider your business plan, future prospects, and tax obligations. Maintaining accurate records of all payments is essential.
Payment Methods
Explore different payment methods and consult your accountant for tailored advice.
As a business owner, determining how to compensate yourself is crucial. The method varies based on your business structure and tax implications.
Depending on your business type, you can use an owner’s draw or salary. An owner’s draw is common for sole proprietorships and partnerships, while a salary is typical for S corporations.
When deciding, consider your business plan, future prospects, and tax obligations. Maintaining accurate records of all payments is essential.
Explore different payment methods and consult your accountant for tailored advice.
Understanding Owner’s Draw
An owner’s draw is essentially taking money out of your business for personal use. It’s not considered a salary, so you won’t deduct payroll taxes. However, you’ll still be responsible for self-employment taxes (Social Security and Medicare) on your profits. The key here is that it’s a distribution of profits, not a wage expense for the company.
Pros of an Owner’s Draw:
- Simple to implement, especially in the early stages of your business.
- Offers flexibility in how much and when you take money out.
Cons of an Owner’s Draw:
- Can lead to unexpected tax bills if you don’t plan accordingly.
- Doesn’t contribute to Social Security and Medicare in the same way as a salary (it’s based on overall profit, not a specific wage).
Understanding Salary
If you structure your business as an S corporation or C corporation, you’re considered an employee of your company. This means you’ll pay yourself a salary, just like any other employee. This salary is subject to payroll taxes (income tax, Social Security, and Medicare), and your company will also pay its share of these taxes.
Pros of Paying Yourself a Salary:
- Provides a predictable income stream.
- Allows you to contribute to Social Security and Medicare through payroll deductions.
- May offer tax advantages in certain situations, particularly with an S corporation, where you can potentially reduce self-employment taxes.
Cons of Paying Yourself a Salary:
- Requires more complex payroll processing and tax filings.
- Can be less flexible than an owner’s draw, as you need to adhere to payroll schedules.
Determining the Right Amount
Whether you’re taking an owner’s draw or paying yourself a salary, it’s crucial to determine the right amount. Here are some factors to consider:
- Your Business’s Financial Health: Ensure your business has enough cash flow to cover your compensation without jeopardizing its operations.
- Your Personal Needs: Calculate your personal living expenses and financial obligations to determine how much income you need.
- Industry Benchmarks: Research average salaries for similar roles in your industry to ensure you’re paying yourself a competitive rate.
- Tax Implications: Consult with a tax professional to understand the tax implications of different compensation methods and amounts. They can help you optimize your tax strategy.
The Importance of Record Keeping
Regardless of the method you choose, meticulous record keeping is essential. Use accounting software to track all payments to yourself, categorizing them correctly as either owner’s draws or salary expenses. This will simplify tax preparation and help you maintain accurate financial records.
Seeking Professional Advice
The best way to determine how to pay yourself is to consult with a qualified accountant or financial advisor. They can assess your specific business structure, financial situation, and tax obligations to provide personalized guidance.
