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How Should Entrepreneurs Pay Themselves?

By Sammi Caramela
Business.com / entrepreneurship / Last Modified: May 1, 2018
Image credit: Efetova Anna/Shutterstock

Business.com Community member Anthony Addesso asked, "I was wondering if it is better to pay myself with a paycheck, or have tax deductions taken out of each pay check, or just take a draw and try to figure out the taxes on my own and pay them quarterly?" We answered.

Being an entrepreneur isn't easy. Not only are you responsible for your business, including sales, customer service, marketing and more, you're 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 pay check, 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.

Business structure

The first step to starting a business is choosing the right structure, and your decision will impact how you handle your income. According to Ina Coveney, BS, MBA, and techie business expert, you should get off a sole proprietorship and 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 are … but also 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."

Payment plans

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 payed 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 bi-weekly 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 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?

You might think it's in your business's best interest to lower your wages, but it's also important not to under-pay 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.

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