How Should Entrepreneurs Pay Themselves?

By business.com editorial staff,
business.com writer
| Updated
Mar 19, 2020
Image Credit: Efetova Anna/Shutterstock

As an entrepreneur, you're the one paying yourself, and it's not always a steady income.

Being an entrepreneur isn't easy. Not only are you responsible for your business, including sales, customer service, marketing and more, you're also your own boss. In other words, you're the one paying yourself – and it's not always a steady income.

Anthony Addesso, owner of Anthony Addesso Architecture, asked the business.com community the best way to pay yourself as a business owner: "Being the owner of a services company, I was wondering if it is better to pay myself with a paycheck, or have tax deductions taken out of each paycheck, or just take a draw and try to figure out the taxes on my own and pay them quarterly?"

This topic is heavily discussed on business.com. After speaking with experts, we outlined tips and steps to paying yourself as an entrepreneur.

What is the structure of your business?

The first step to starting a business is choosing the right structure; your business structure impacts how you handle your income. According to Ina Coveney, a corporate trainer and entrepreneur, you should create a single-member LLC right away. [Want to change your business structure? Here's how.]

"Not only will it have no impact on how your taxes … but you will be incentivized to behave as a business to prevent from piercing the corporate veil," said Coveney.

You'll also have your own business account and credit card, separating your personal finances from business expenses, she added.

"Basically, every entrepreneur should have a sub S or LLC corporation, not only for liability protection, but so they can set up a SEP-IRA or other retirement vehicles," added Terence Michael, president and executive producer of 100% Terry Cloth Inc. "This way, they really are paying themselves first, but in a tax-deferred or tax-deductible method."

How to pay yourself if you're an LLC or sole proprietor

For LLC owners

According to LegalZoom, there are two common options for paying yourself from an LLC; as an employee with wages or as a distribution from profits. When choosing to pay yourself as an employee, you can receive regular payments throughout the year, which is recommended for those needing regular income. In order to pay yourself a salary as a single-member LLC, you must be the owner of the LLC and an active worker in the business. Regardless of how you pay yourself, whether it be through wages or profit, you are still responsible for following the IRS guidelines and regulations. The salary you pay yourself must meet the deduction requirements set forth by the IRS, and you'll need to file a W-4 with the IRS to determine how much money should be withheld from each paycheck, because you will pay income taxes on the earned wages.

If you opt for distribution from profits, you can set up a draw for ongoing payments against the year-end profits. If the LLC has more than one partner, it is considered a partnership by the IRS, so you each must report your share of the profits and pay income tax on that amount.

You may choose to work as an independent contractor through an LLC, which means you will need to file a W-9 and 1099 at the end of the year. As an independent contractor, you are responsible for paying self-employment taxes on the amount you earned.

For sole proprietors

As a sole proprietor, you can choose to pay yourself when you want, which is generally done by writing yourself a check in the amount of money you want to withdraw from the business account. Keep in mind that each time you pay yourself, it is not a salary, but money from profit, so there are no deductions for Medicare or Social Security – you are responsible for paying self-employment tax, so it's important to put aside money for these expenses.

Establishing a payment plan

Nate Masterson, marketing manager for Maple Holistics, offered two popular ways to pay yourself.

Draw

According to Masterson, when a small business owner pays themselves, it's called an owner's draw. Owners of LLCs and partnerships aren't paid through regular wages; instead, they're paid with owner's draws, which aren't taxed until later, he said.

Salary

"A salary is appropriate if you are involved in the day-to-day operations and are seeking compensation for your work, as the IRS will expect you to compensate with a recurring payment that is accounted for in payroll," said Masterson. "In this way, you are less likely to be in a sticky tax situation, and you'll be able to enjoy your money more easily without the IRS and taxes hanging over you."

Michael advised running quarterly payrolls for yourself.

"I typically prefer quarterly payrolls over weekly or biweekly payrolls. It saves paperwork and administration so the owners can concentrate on the bigger, deeper swings and not get distracted by compliance," Michael said. [Need help with payroll? Check out our picks for the best online payroll services.]

To determine which payment option is best for you, consider your business structure, said Ray Badger, president of Turbo Technologies Inc. and member of the business.com expert community.

"If you are a sole proprietorship, [you] could just take a draw and figure out the taxes quarterly," he said. "If you are an S-corp, C-corp or LLC, you would be better off taking a paycheck and taking your taxes out at that time."

How much should you pay yourself?

You might think it's in your business's best interest to lower your wages, but it's also important not to underpay yourself. According to Jennifer E. Myers, CFP and president of SageVest Wealth Management and financial literacy site SageVest Kids, this limits your Social Security and other benefits, impacts sales and is often a red flag to the IRS.

"One of the most tempting ways for business owners to keep their company expenses low is to pay themselves very little, or even nothing, in the form of W-2 income," Myers said. "While this strategy lowers your payroll expenses and some tax liabilities, there are potential long-term personal and business costs."

It's best to pay yourself for the job you are doing. How would you reward an employee in your position, doing your work?  Make sure it's reasonable, covering your personal expenses without leaving your business empty-handed.

business.com editorial staff
business.com editorial staff
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