It is important to pay yourself correctly
Paying yourself correctly is key to managing your personal finances, staying compliant with tax rules and keeping your business healthy. There are many reasons you might choose to adjust how you pay yourself over time, from tax planning to personal financial goals, and the right approach can be highly individualized. The best method varies based on your business structure, tax brackets and overall tax strategy.
Owner’s Draw:
- Common for sole proprietors and single-member LLCs
- You can take money out of the business account as needed; it isn’t treated as a salary and no payroll taxes apply at the time of withdrawal
- You’ll pay taxes on the business’s net profit regardless of how much you draw. This will be calculated based on your personal overall taxable income.
Salary:
- Required if you are an employee of your corporation, such as an S corporation or C corporation
- Subject to payroll taxes including Social Security and Medicare, and you’ll need to process through payroll like any other employee
- The IRS expects reasonable compensation for services provided so underpaying yourself to avoid taxes can lead to penalties
Distributions:
- Typically used for S corporations and partnerships after paying reasonable salaries and covering business expenses
- Distributions represent profit passed through to owners and are taxed on your personal tax return
- This method can provide tax advantages compared to taking the same amount purely as salary
Tips:
- Keep business and personal funds separate to protect your legal structure and simplify accounting
- Set aside funds for taxes when you pay yourself to avoid year-end surprises
- Consider setting a regular schedule for draws or distributions to help with budgeting
- Consult a tax professional to ensure you are paying yourself properly for your entity type and situation
Final Thought:
Paying yourself the right way depends on your business structure and growth goals. Taking the time to plan helps you avoid tax issues and ensures both you and your business stay on solid financial footing.
