Now that you’re done with your divorce mediation, you can focus on running a new small business. As the owner, you naturally want to earn sufficient income or earn enough to comfortably attend to your daily needs. But as you may know, paying yourself could sometimes feel like you’re in a tug of war between the needs of your business and your personal needs.
To determine the right balance, you should do the math and identify how much your small business requires and determine how your personal income might be taxed. Here’s a quick guide to start you off.
Finding That Perfect Number
Begin by reviewing your numbers. How much does your business spend on expenses, how much revenue you’re making, and how much money you have on-hand? Check all previous numbers, not just the recent ones, and then forecast the expenses and revenue for the coming months.
Don’t forget to factor in your annual and occasional expenses, expected fluctuations, and expansion plans. You should also consider all potential taxes that might apply to you. This might mean factoring in unemployment and payroll taxes besides business income and personal taxes.
Utilize your findings to determine the amount you need to keep your business afloat, along with ample cushion, if your forecasts don’t come to fruition. Done right, you’ll have come up with a number that you should pay yourself and co-owners, if applicable.
Figuring Out How You Should Pay Yourself
Generally speaking, you can opt to pay yourself through a salary, draw, or a mix of both. With the draw method, you pay yourself a direct draw from your business. With the salary method, your salary goes through your payroll process that includes withholding your taxes. With a combination payment method, some of your income will come from a direct distribution or draw, and the rest will come from a salary.
Choosing Which Method to Pay Yourself
To decide on a payment method, determine your business entity for tax purposes. For instance, LLCs might be taxed as corporations, partnerships, or sole proprietorships, while corporations might be taxed as a C or S corporation.
If you’re in a general partnership or a sole proprietor, you’re not an employee of your business but are considered the business itself. This means that you’ll pay yourself a direct draw and pay taxes quarterly, which includes estimated federal and state income taxes as well as self-employment taxes that cover Medicare and Social Security.
If your small business’s entity is a corporation and you’re an employee of your business, you must pay yourself with the salary method, including withholding taxes. However, you are not legally required to take your entire compensation as salary but can take a distribution or draw as well.
If your business is an S corporation, the business profits will flow through all owners’ personal tax returns. Owners’ salaries are subject to payroll taxes. However, profit distributions are not. Likewise, some owners experience tax savings when they limit their salary and then take the rest of their compensation as a draw.
It’s also vital to note that the IRS requires that your salary is reasonable considering your level of experience and position. In this light, it could be difficult to determine how a draw or salary would impact your personal and business taxes. So seeking advice from an experienced professional is recommended.
Once you have figured out how much you should pay yourself and how to stick to a regular schedule, you should reevaluate throughout the year and tweak things as needed to ensure that you’re meeting your personal and business obligations and goals.
