Paying yourself can be a tricky topic for many business owners. Often times, I run into people who have no real system of pulling a personal income from the business revenues; they just sort of take chunks of money at a time when they need it. Although it’s normal, it’s really not the best way to pay yourself. The best method for paying yourself as a business owner is a somewhat complicated topic, but putting a system in place to help you manage your money is the first step to really understanding how to pay yourself and how to maintain your company’s financial health simultaneously. There is no single correct way to pay yourself, it really just depends on several factors.
Below are a few things to understand so that you can create the best method for paying yourself.
Determine Your Company’s Level of Cash Flow
The first thing to be determined is your company’s ability to pay you. Like seriously, as yourself, can I afford to pay myself a salary right now? No shade, but most business owners are not in a position to receive a salary in the beginning stages of their business, specifically between year 1 and year 3. Personally, I did not receive a salary until year 3 of my business because most of my profits were being reinvested back into my business so that my business can be in position to earn more profit and run smoothly. It’s very important to ensure that your company has the appropriate cash flow before you consider paying yourself a salary. Seriously, if your company is not making enough money (i.e. has a cash flow issue), then your energy should be focused on how to generate more revenue, so that you actually have the ability to cut yourself a check. On the other hand, if your business is actually making decent money but you’re not seeing a lot of money left over (profit), then you may have too many expenses. When you’re looking at your cash flows, take a look at those monthly expenses…sometimes it’s not necessary to have all those expenses. When you’re starting a business, your focus should be to operate as smooth as you can, while minimizing your expenses as best as you can. Developing a company budget should help with that tremendously.
What Type of Legal Entity is Your Company?
Once you have determined your legal structure, you need to consider the tax consideration of that particular structure. If you’re a Sole Proprietor or LLC, the profits (and losses) pretty much pass directly through the owner. That basically means that all the profits made by the company will be reported on your individual tax return, whether you pay yourself a salary or not. However, just because all the profits will pass through the owner doesn’t mean you can’t be disciplined enough to put yourself on a schedule and pay yourself the same amount of money each week, bi-week, month or quarter. Now, if your company is a S-corporation or C-corporation, the company itself is not subject to federal taxes or self-employment taxes like Sole Proprietorship or an LLC, however, the owners are taxed on their “share” or percentage of ownership of the company. If you’re a Corporation, you should probably get a payroll system to pay yourself. An owner of a Corporation will have to carefully determine a fair salary for each person working in the company because the IRS will quickly intervene if it’s not considered “reasonable” according to their standards. Paying yourself under a corporation can be a little tricky, so it’s best to outsource the payment of your salary to an accountant, payroll administrator or a bookkeeper.
So How Should I Actually Pay Myself?
If you’re a Sole Proprietor or a LLC, the first thing to do is set a monthly budget based on your personal needs (housing, food, bills, personal items and entertainment, savings, etc.) and determine the amount you actually need to be paid in order to live comfortably. Once you have determined your budget, you should determine the frequency at which you want to pay yourself. For record keeping purposes, you should write yourself a check from your business account and deposit it to your personal account or if your personal account and business account are at the same bank, you can simply make an online transfer to your personal account. The idea is pay yourself on a routine basis. It’s best to choose the same day to get paid (every Friday, every other Friday, last day of the month, etc) and to pay yourself about the same amount of money each payday. When you make the transfer, you should record it on your financial books as a “owner’s draw” so that this money will not be counted as an expense. Oh, and don’t even think about trying to count it as an expense, because If you ever get audited by the IRS and your bank records are requested, they WILL know that those transactions are your salary. If they don’t know for sure, they will question you about it and ask you to show proof. Don’t cheat, because they will surely find out and there will be penalties galore if they do.
I personally pay myself once per month because it helps me stick to my personal budget. It also helps me to truly see my profits for the entire month. I may give myself a bonus every now and again, or take a pay cut depending on my profits for the month; but for the most part, my salary is about the same each month. When I pay my company bills and other recurring expenses, I add myself into the mix and I pay myself as if I’m paying a bill. Paying yourself on a schedule not only helps you live within your means personally, but it also helps you to become more disciplined with your finances. Budgets are not always fun, but mastering your finances is a MAJOR KEY to your success. Even millionaires follow a budget, it’s really just about discipline.
Again, it’s very important to ensure that you can afford to take a salary. I paid myself sporadically during the first 2 years of my business because my profits were just that, sporadic LOL! But once my profits became consistent, paying myself has become consistent. Always ensure that your business bills are paid and you’ve saved money for business emergencies and taxes BEFORE paying yourself. I know that sounds crazy, but we have to keep the business afloat until it can handle paying both you and the expenses. If you’re in the beginning stages of your business, try to depend on a 9-5 to help you manage your personal expenses, and just use your business profits for savings and reinvesting in the business until it earns enough to replace your 9-5 income.
I really hope this helps you get some clarity on paying yourself! If you have any specific questions, don’t hesitate to shoot me an email at email@example.com!
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