Running your own business is a dream come true for many entrepreneurs. Being in charge of your own destiny, making decisions, and creating something from scratch are just some of the perks. However, one of the biggest challenges that self-employed individuals face is figuring out how to pay themselves. Unlike traditional employees who receive a regular paycheck, business owners need to be strategic about how they pay themselves to ensure that they are being compensated fairly while also keeping the business’s finances in check.
In this article, we will explore some of the ways that business owners can pay themselves and offer tips on how to determine the best method for your unique situation.
Understanding the Different Ways to Pay Yourself
When it comes to paying yourself as a business owner, there are several options to consider:
- Owner’s Draw
- Salary
- Distributions
- Dividends
Each of these methods has its own pros and cons, and the best option for you will depend on the type of business you have, your financial goals, and other factors.
Owner’s Draw
An owner’s draw is the most common way for business owners to pay themselves. This method involves taking money out of the business as needed, much like you would withdraw cash from a personal bank account. Owner’s draw is most commonly used by sole proprietors, partnerships, and LLCs, as these business structures do not require owners to pay themselves a regular salary.
Pros:
- Flexible: You can take money out of the business whenever you need it.
- Simple: There is no need to set up payroll or file taxes for a salary.
Cons:
- Inconsistent: Your income may vary from month to month, making it hard to budget.
- Tax implications: Owner’s draw is subject to self-employment taxes, which can be higher than income taxes.
Salary
Some business owners choose to pay themselves a regular salary, much like traditional employees. This method is most common among corporations and larger businesses, as these structures require owners to pay themselves a salary to avoid potential legal and tax issues.
Pros:
- Consistent: You will receive the same amount of money each pay period, making it easier to budget and plan.
- Tax advantages: Paying yourself a salary can help reduce your self-employment tax liability.
Cons:
- Administrative burden: Setting up payroll and filing taxes can be time-consuming and expensive.
- Less flexibility: You may not be able to adjust your salary as easily as you could with an owner’s draw.
Distributions
Distributions are similar to owner’s draw, but they are typically used by LLCs and partnerships to distribute profits to owners based on their percentage of ownership.
Pros:
- Tax advantages: Distributions are not subject to self-employment taxes.
- Flexible: You can take money out of the business whenever you need it.
Cons:
- Inconsistent: Like owner’s draw, your income may vary from month to month.
- Not available for all business structures: Corporations cannot use distributions as a method of paying owners.
Dividends
Dividends are a method of distributing profits to shareholders in a corporation. This method is only available to corporations and requires the business to have issued stock to shareholders.
Pros:
- Tax advantages: Dividends are taxed at a lower rate than regular income.
- Consistent: Once declared, dividends are paid on a regular schedule, making them predictable.
Cons:
- Not available for all business structures: Only corporations can issue dividends.
- Complex: Issuing dividends requires following strict legal and financial regulations.
Conclusion
As a business owner, it’s important to carefully consider your options for paying yourself. Each method has its own advantages and disadvantages, and the best choice for you will depend on several factors, including your business structure, financial goals, and personal preferences. By understanding the different ways to pay yourself and seeking the advice of a financial professional, you can ensure that you are being compensated fairly while also keeping your business’s finances in check.