How Business Owners Should Pay Themselves

business owner checking his phone

One of the most common struggles for small business owners is determining how to pay themselves. Often, it’s an afterthought – which can come back to bite you when money is tight.

If you’re a small business owner, this is how you can determine your payment structure.

Know the Types of Compensation

There are a few different ways that business owners can pay themselves, and the right approach depends on your business size, number of employees, revenue, and your needs.

There are two primary options: through owner’s draw, or through salary. Here are the differences between the two.

Option 1: Owner's Draw

An owner’s draw is essentially just taking money out of the company to pay yourself. This can work well for business owners who don’t operate on a 40+ hour per week schedule and don’t need consistent pay. For example, if you only work 20 hours a week then you may take less money.

However, the danger with owner’s draw is inconsistency. It’s very easy to both underpay yourself or to draw too much money from the business. It also can make it harder to budget effectively, especially if you’re deciding your compensation month-to-month and it changes dramatically.

Even with those limitations, owner’s draw can still be the right choice in certain situations. If you’re just launching your business and aren’t out of the red, paying yourself via owner’s draw makes sense. If you’re a sole proprietor, owner’s draw typically makes more sense over salary.

Option 2: Salary

Salary is a more typical compensation strategy, where you pay yourself a set amount each year.

Consider a salary once your business has sustained revenue, consistently projected revenue, and is in the black.

Many business owners are hesitant to give themselves a salary, but it’s typically the best approach, for a few reasons:

Salary is more equitable if you have co-owners
It ensures consistency, which makes budging easier
There are a number of tax incentives
It’s a requirement for S-corporations or C-corporations or a limited liability company taxed as a corporation

The next step is deciding what a fair compensation is. The IRS requires that compensation be reasonable: “Wages paid to you as an officer of a corporation should generally be commensurate with your duties.” In other words, look at the average salaries of similar jobs to what your duties entail to determine a reasonable salary.

Salary is also different from owner’s draw in how taxes are paid: with a salary, taxes are deducted up front. With owner’s draw, you’ll need to keep track of what you pay yourself and then pay taxes during tax season.

Work with A Business Financial Advisor

So which option is right for your company? It depends! Greater Midwest Financial Group can help find the best solution for your specific needs.

At Greater Midwest Financial Group, we understand small businesses. We know your time is valuable; that’s why we work to simplify your finances and help you prepare for the future. Whether you own a family business, a dentistry or another small business, our personal financial advisors are dedicated to deeply knowing your business and helping you take on every challenge.

Small business services

Coordinate Business & Personal Planning: When you spend so much time at your business it hard to coordinate your Business Life with your Personal Life, we can help!
Wealth Accumulation & Preservation: You work hard at your business and are good at what you do BUT how do you maximize your efforts and create a retirement nestegg.
Benefit Plan Consulting including Key Person Retention Strategies: How do I attract quality employees and make sure I retain them and my key employees? You need a benefit plan consultant to put in the benefits so they join your firm and stay.
Retirement Plan Consulting: When I get advice on what type of retirement plan I should have for my business and employees how do I know I am getting the best advice? You need someone who works to put you interest first. With 35 years of experience, we can help.
Business Succession Strategies: How can I actually pass this business on to my family or a key person? You’ve worked hard but having a solid plan seems overwhelming. GMFG has been experience, resources, and service model to help you put this together.
Tax Planning: Coordinate your personal and business tax planning needs.

Greater Midwest Financial Group is a financial advisor firm serving St. Paul, Minneapolis and the wider Twin Cities area. We specialize in wealth management, retirement planning, asset management and other personal finance needs.

References:

LendingTree, “How to Pay Yourself as a Small Business Owner ”

Business News Daily, “Entrepreneur Salaries: How Much Should You Pay Yourself? ”

IRS, “Paying Yourself”