The Best Ways to Pay Yourself as a Business Owner
Like many busy business owners, you have undoubtedly worked hard and been busy building your company into a success. Whether you are an artist, electrician, or pet groomer, once your business is up and running, the question becomes how to reap some of the rewards of your efforts.
Paying yourself as a busy business owner may seem complicated as there are different rules based on the structure of your business as well as various tax laws. However, once you get a general idea of the options available, selecting the best way to pay yourself can be painless.
Choose Your Business Structure
As a preliminary matter, it is important to decide which business structure you will choose for your company. Different structures have different rules about how owners can pay themselves. A good practice is to write down what aspects of business structure you find most appealing before choosing.
For example, if you are most concerned with liability protection, you should look into forming a C - Corporation, S - Corporation, or LLC. If your main concern is the ease of formation, a sole proprietorship may be the best structure for you. Regardless of the structure you choose, you will have flexibility in choosing the best way to pay yourself as a business owner.
Payment Under Sole Proprietorships
Sole proprietorships are the most common type of business structure today. The biggest benefit of sole proprietorships is they do not require formal paperwork, so little or no cost is needed to form your business.
However, prospective business owners need to remember that sole proprietorships do not offer liability protection. Practically speaking, this means that if the business were to be sued at some point, the owner’s personal assets could be subject to the lawsuit. Owners of sole proprietorships are also subject to the self-employment tax.
An owner of a sole proprietorship is considered self employed and cannot take a salary. Instead, the owner can simply take money from the business account whenever they need. This payment method is known as an owner’s draw. There are no tax withholdings when taking an owner’s draw, but an amount should be set aside to cover taxes due at the end of the year.
Payment under a C - Corporation
A C - Corporation is the type of business structure most people think of when they hear the word “corporation.” C - Corporations are popular for offering limited liability. Owners can pay themselves with a salary if they are employees of the corporation, or through dividends received from the corporation as owners.
The downside of forming a C - corporation is that income is taxed twice, once when the corporation files its tax return, and once when the owner receives income from the corporation. Although double taxation is a drawback to forming a C - corporation, the relative flexibility in setting rules the corporation must operate under as well as personal liability protection make them popular among prospective business owners.
Payment Under an S - Corporation
S corporations are not as widely known as C - Corporations, but are gaining in popularity. One of the biggest advantages of forming an S - corporation is that the business can elect to “pass-through” its income, losses, and deductions to its shareholders without being taxed at the business level.
The business owner can choose between two methods to pay themselves under an S - Corporation. First, the owner may choose to become an employee of the company and take a salary just as every other employee does. The other option is for the owner to take dividends as payment. Dividends have the advantage of offering lower tax rates than a salary, but payments are made less frequently than with a standard bi-weekly paycheck.
Payment Under an LLC
An LLC is a business structure similar to an S - Corporation in that it offers limited liability to its owners while also allowing income to pass through to its members. LLCs are one of the most popular types of business structures due to the relative ease of formation and flexibility in creating rules on how the LLC operates.
Owners of an LLC can choose to pay themselves by taking an owner’s draw, or a salary if they are employees of the LLC. Unlike an employee’s salary, there are no tax withholdings associated with an owner’s draw. Therefore business owners need to be careful to set aside a certain amount to pay taxes on income received through the LLC at the end of the year if taking an owner’s draw.
Other Methods and Final Thoughts
Please keep in mind that the methods we have discussed above are not the only ways busy business owners can pay themselves.
For example, owners can also take distributions from the company as payment instead of taking an owner’s draw or salary. The details of this method are beyond the scope of this article, but there are tax advantages to alternative payment methods and are worth discussing with your accountant.
We hope this short article has been informative and given you an idea of different ways to pay yourself as a busy business owner. There are advantages and drawbacks to each method, but choosing which is appropriate to maximize your income can be straightforward once you familiarize yourself with the different options available.
