"How should I pay myself?" sounds like a simple question. The answer depends almost entirely on how your business is structured, and each structure has its own rules for taxes and paperwork.
Sole proprietors and single-member LLCs
You take an owner's draw: you simply transfer money from the business account to your personal account. A draw isn't a business expense and doesn't go through payroll. You're taxed on the business's profit whether you take the money out or leave it in, and you pay income tax and self-employment tax through quarterly estimated payments.
Partnerships and multi-member LLCs
Partners aren't employees, so they don't receive W-2 wages from the partnership. Instead, partners can receive guaranteed payments, fixed amounts for their work regardless of profit, and distributions of profit. Guaranteed payments are generally subject to self-employment tax. Your partnership agreement should spell out how each one works, so there are no surprises among partners.
S corporations
As an owner who works in the business, you're an employee. You must pay yourself a reasonable salary through payroll, with taxes withheld, before taking distributions of remaining profit. Two rules matter most. Your salary has to reflect what you'd pay someone else to do your job. And distributions generally have to follow ownership percentages, because S corporations can only have one class of stock.
C corporations
Owners who work in the business are paid a salary through payroll, which the company deducts. Profits paid out as dividends aren't deductible to the company and are taxed again to the shareholder. That's why many C corporation owners lean toward salary, though compensation that's unreasonably high for the work can also draw IRS attention.
Whatever your structure, decide on purpose
- Keep enough in the business. Leave room for taxes, upcoming expenses, and a cash cushion before deciding what's left to take out.
- Pay yourself consistently. A regular amount on a regular schedule makes both your business and personal budgets easier to manage.
- Set aside taxes as you go. If nothing is withheld, move a fixed percentage of every payment into a separate tax account.
- Record it correctly. Draws, distributions, and salary are each recorded differently in your books. Mixing them up causes problems at tax time.
- Revisit it every year. As profit grows, the right structure and the right amount may change.
We'd pay ourselves a steady, modest amount on a fixed schedule, and leave the rest in the business until quarterly taxes and a cash cushion were covered.