As a small business owner, deciding how much to pay yourself is critical. The right strategy will help you balance your needs and your company’s growth. There are many different ways to pay yourself as a business owner, each with varying personal income and tax implications. Learn about the various options, including salaries, dividends, and owner’s draws.
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Salaries
A salary is a fixed amount you receive regularly, such as weekly, bi-weekly or monthly. There are different ways to pay yourself, and it’s also a good way to keep your personal and business expenses separate. However, it may only be the best option if your business is profitable, as it will deplete your operating capital. If you are still in the early stages of your business, ensure you have enough cash flow to cover your operational expenses and estimated taxes before paying yourself a salary. The IRS has a “reasonable compensation” requirement when setting your salary. Your salary must be comparable to what others in similar positions would earn if they worked for another company. If you choose to take a salary, you must set up payroll and withhold taxes like you do for your employees. It may be easier if you have an accountant or payroll service that calculates and sends payments to taxing authorities and generates paychecks and W-2 forms for your employees. You can also opt to be paid a percentage of your business’s profits. It can be a motivating factor to drive your company’s profitability. However, reviewing your living costs and business performance numbers regularly is important to ensure that this payment method still makes sense for you.
Owner’s Draw
Owner’s draws are a common way for business owners to take personal income from their company. Several factors, including the longevity and success of the business and individual budgetary needs, can determine the amount you draw from your company. It’s important to balance these factors to ensure you receive reasonable compensation while not draining your business. When you take an owner’s draw, the money comes from your company’s equity – the funds you have invested in the industry, plus your share of the business’s profits. It’s similar to a dividend, but you can withdraw the money at any time and use it for personal purposes. You can remove the funds from your business’s bank account through debit or ATM withdrawal, online fund transfers, or by writing a check. If you want to make the process more official, you can also set up a separate bank account for funds transfers between this account and yours. The biggest difference between a salary and an owner’s draw is that taxes are automatically withheld from each paycheck when you pay yourself a salary. However, with a draw, you are considered self-employed, so it’s your responsibility to keep track of your withdrawals and file quarterly estimated tax payments. It would help to speak with a qualified tax professional before choosing the best option for your business.
Loans
Sometimes, a business owner can use a loan to extract cash from their company. It can be a good option for those establishing their business or for those needing to grow their bottom line. However, this process should be done with a financial advisor to ensure the proper procedures are followed. The lender must be formally notified of this intention and may require the submission of various financial information. It could consist of pay stubs, business and personal bank statements, or other evidence of revenue.
Additionally, the lender must be notified of any potential collateral that may be used in the event of default. The IRS also keeps a close eye on those who take loans from their businesses, and our firm can help ensure that the proper documentation is in place to avoid an IRS claim that these loans are disguised compensation. Ultimately, the most appropriate method for your situation will depend on some factors, including your business structure, the stage of your company and the amount of money you need to withdraw from the business.
Dividends
Whether you should take a salary, dividends, or a combination depends on your business type and tax structure. C corporations are taxed at the corporate and individual levels for profits, whereas other business structures are considered pass-through entities, and taxes are only paid on income. As a business owner, you can declare and take a dividend from your company at any time, provided it is cash. The cash can then be withdrawn from the corporation by writing yourself a check characterizing it as owner’s equity or a dividend disbursement and depositing it in your account. Since this payment method does not require registering with the CRA and remitting payroll taxes and source deductions, it is an attractive option for some entrepreneurs. However, it’s important to note that this cash withdrawal from the company will result in a lower profit margin for your business. Also, taking out too much money could prevent you from running out of working capital and putting your business at risk. For these reasons, it’s always a good idea to consult a certified accountant to discuss your unique situation and goals before deciding.
