When starting your own business, the first thing that usually comes to mind is "how much is all of this going to cost me?" instead of "so, when do I get paid?" In the beginning, paying yourself may seem like lightyears away especially when start-up costs start racking up but in order to get a more accurate depiction of the health of your business, it is important to account for one of the biggest expenses: your take-home pay. Let's take this expense off the back burner and discuss the best way to go about paying yourself.
Salary vs. Owner's Draw
Before we get into the nitty gritty, let's start with some basics. Some business owners choose to pay themselves a salary while other's pay themselves with an owner's draw. So, what's the difference?
Choosing the correct method is highly dependent on your businesses structure and its' stage of growth...
Salary: You may be more familiar with this method if you've ever worked for a company prior to owning your own business. If your business is structured as a LLC taxed as a corporation, S-corporations, or C- corporations, you are required to pay yourself through a salary. You would pay yourself like you would an employee with taxes taken out of your paycheck. Trigger warning: IRS... It is also a requirement by the IRS to pay yourself "reasonable compensation" meaning it should be comparable to what other's in your position are making.
Owner's draw: If this is your first time starting a business, you may be a little less familiar with this method. This way of compensating yourself can be very beneficial if you don't exactly know the health of your business quite yet. You simply draw money from your businesses profit when you see fit. Unlike a salary, you can draw any amount at any given time. Say one month your business is soaring, you could take home a larger portion while slower months, you may want to take home a smaller amount. But wait, what about taxes? While you aren't required to pay the taxes up front, you should set some funds aside for tax season.
Which method is best for your business?
Owner's draw. Sole proprietors and partners pay themselves by withdrawing funds from the business
Salary. S-Corps and C-Corps typically pay themselves a salary like you would receive with a typical job.
Owner's draw or salary. The tax structure of your LLC would determine the best method for you. If your LLC is structured as a sole proprietorship, it would be owner's draw but if it's structured as a corporation, then you would pay yourself a salary.
How Much Should You Pay Yourself?
The IRS suggests you pay yourself a "reasonable salary" but what's considered reasonable and how do you determine that?
Calculating Personal Expenses
When considering your pay, take a look at your day-to-day living expenses and debt repayments such as mortgages, car loans, student loans, etc. It's also important to consider a plan for retirement and insurance expenses. The early stages of your business can be tough as far as seeing profit but it's important to have your personal expenses met once you get the ball rolling.
Calculating Business Needs
You'll want to leave enough money in the business for its every day operations. It's important to calculate your business's monthly expenses and take note of due dates to have a better idea of what exactly you owe and when. You'll also want to keep a little cushion in case any unforeseen expenses come up like if your computer or any machinery goes kaput. Think about your businesses future as well... Do you want new hires? New machinery? A new store front? Keep your business goals in mind to have a better idea of how much you want to take home every month.
Calculating Tax Savings
Taxes... That word has a sting to it, doesn't it? No one likes to pay taxes but it's better to be prepared rather than surprised and I don't mean surprised in a good way. Taxes are non-negotiable so while there might be some work-around in other expenses, these are set in stone. We suggest you set aside 30% of your profit (revenue - business expenses) for taxes. You'll want to subtract monthly tax savings from your profit to help you get a more accurate number of what you can take home. Setting this money aside may feel painful but I promise come tax season, you'll be patting yourself on the back.
Let's Be Real
In a perfect world, your expenses as a whole are less than what you can pay yourself and if this applies to you then you are living the dream but most of the time this isn't the case. Pay close attention to the growth of your business and what it needs to succeed but don't put your personal needs aside either. Finding a balance between personal and business needs as well as taxes may seem like the impossible but this is where prioritizing comes in to play. You may not have enough room for shiny new toys some months but being realistic with your finances will never lead you astray.
If you keep your financial priorities in mind as well as your personal and business goals, you should have a clear understanding of how much you should take home each month.
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