How to Legally Pay Yourself as an Entrepreneur

Hi there, dreamers & dynamos,

Welcome to Payments 101.

Say Hello to Paychecks, Salaries, and Owner's Draws

So you've taken the plunge into the entrepreneurial world, guiding your own ship and chasing your dreams. Congratulations, my friend! But let's face it, dreams don't pay the bills (unless you're dreaming of stacks of cash). So how do you legally pay yourself as an entrepreneur?

Don't worry, I've got you covered.

In this article, we'll dive into the nitty-gritty of determining your salary, transferring funds, setting up essential bank accounts, and even accepting those sweet, sweet cash payments. Let's get that moolah flowing, shall we?

Step 1: Keep Your Business and Personal Bank Accounts Separate (It's that Seriously Important)

Alright, we know there's like a gazillion different things to manage as a small business owner, but listen up: keeping totally separate personal and business bank accounts is a MUST, no matter the legal structure of your business. We're talking S-Corp tax structures, sole proprietorships, heck—even if you own a lucrative lemonade operation, it's so important to have a separate fund for business expenses. Trust us; you'll thank us later.

Alright, now that your finance ducks are in a row, let's talk about getting paid!

Paying Yourself through a Paycheck (The Salaries Way)

Let's kick off with the most traditional form of payment: the good ol' paycheck. This method of paying yourself is perfect for businesses that are set up as an S-Corp, a tax status you can elect when forming an LLC. In simple words, when you're an S-Corp, you pay yourself a "reasonable" salary in the form of a regular paycheck. This paycheck will have payroll taxes deducted, just like you'd see in any traditional job.

But wait! What qualifies as a "reasonable" salary? The IRS is pretty vague when it comes to what counts as reasonable, but we can tell you this much—paying yourself the big bucks might raise some eyebrows. On the flip side, giving yourself a salary that's barely enough to cover a couple of lattes every week is probably cutting it too close, too. Strive to find a happy medium that's in line with the industry and experience levels. Consider what it would cost to replace yourself.

Pro tip: consult with an HR professional that knows the industry and can help you decide on what's reasonable for someone with your skill set.

Taking an Owner's Draw (Cha-ching!)

If you're rocking the sole proprietorship or your LLC is taxed as a partnership, you can pay yourself through what's called an "owner's draw." An owner's draw means you can withdraw money from the company's profits. Pretty sweet, huh?

Here's the catch: when you take an owner's draw, you need to remember that you'll be responsible for paying the taxes on those earnings when it comes time to file your personal income taxes. Yep, Uncle Sam wants his share, and it's essential not to forget this crucial step to avoid heartache come tax season.

It's crucial to establish a regular schedule for your owner's draw payments and document them correctly. Regularity creates consistency and avoids confusion down the road for both you and, most importantly, the tax man. Consult with a financial advisor or accountant to help you keep track of your owner's draws and ensure you're setting aside the appropriate amount for taxes.

What About Salaries vs. Owner's Draws for LLCs?

Now, if you're strictly an LLC, things get a little more interesting. LLC owners (a.k.a. members) aren't considered employees, so they don't receive a salary or paychecks like an employee would. The only exception is if you elect to be taxed as an S-Corp (more on this below!). Instead, LLC members receive funds through an owner's draw or guaranteed payments.

Let's break down guaranteed payments real quick: they're more like a fixed salary than an owner's draw, in that they're based on contract agreements. These payments don't hinge on your LLC's profitability but are more about compensating you for the work you contribute to the business. Who says effort shouldn't be rewarded, right?

As an LLC owner, you must file your business's profits, losses, and credits on your personal income tax return (Form 1040), whether you've taken an owner's draw, received guaranteed payments, or elected for S-Corp tax status. This ensures you're paying the correct amount of taxes based on your portion of the business earnings.

Electing for S-Corp Tax Status: Salaries, Paychecks, and More

For some LLC owners, it might make sense to elect for S-Corp tax status. The main advantage? It can save you some dough come tax time—and who doesn't love extra cash in their pocket?

When you're taxed as an S-Corp, you'll pay yourself a salary via paychecks, just like we mentioned earlier. Your LLC still needs to report its profits, losses, and credits on your personal income tax return (Form 1040), but your paycheck will already have payroll taxes deducted from it. This means you won't have to worry about setting aside extra money to pay those pesky taxes.

The decision to become an S-Corp taxed entity is not one to take lightly. Consult with an accountant or financial advisor to help you make the right choice for your specific business situation.

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Varying Amounts and Salaries:

Here's the deal, friend. As an entrepreneur, your income may not be a set amount every month. Some months, you'll be rolling in it like Scrooge McDuck diving into his money bin, and other months, you might be scraping the bottom of the barrel. That's just the reality of running your own show. But fear not, there's a way to navigate this roller coaster.

Transferring Funds and Essential Bank Accounts:

When it's time to pay yourself, transfer a consistent amount from your business account to your personal account regularly. This not only ensures a smooth financial flow, but it also helps you maintain a clear distinction between your business and personal finances and document, document, document.

Saving for Reinvestment and Emergencies:

Look, I get it, when the cash starts flowing, it's tempting to treat yourself to a shopping spree or a fancy vacation. But, it's crucial to save some of that green for future opportunities and emergencies. Just like that emergency kit you keep in your car in case you run out of gas in the middle of nowhere (we've all been there). Having a safety net is essential for the sustainability and growth of your business.

Make it a habit to set aside a portion of your income for reinvestment in your business and building an emergency fund. You never know when that unexpected expense or opportunity might come knocking, and trust me, you'll thank yourself when you're prepared for it.

Accepting Cash Payments:

Now, let's talk about accepting good ol' cash payments. Ah, the feeling of cold, hard cash in your hands. It's a beautiful thing, but it does come with its own considerations. When accepting cash payments, maintain a record of each transaction to keep track of your income accurately. If you don't want to carry stacks of cash around like some sort of walking bank, consider investing in a secure cash register or a mobile payment solution.

Make sure you deposit the full amount of cash into your business bank account each and every time. Now succumbing to convenience and using a portion to pay for gas or a quick latte. Even if you document the discrepancy, it’s best practice to deposit in full.

Cash is king, but being organized is queen. Keep those receipts handy, track those transactions, and stay on top of your finances like the boss you are.

Wrap-up:

Congratulations! You've just earned your degree in Paying Yourself 101. By determining a reasonable salary, setting up essential bank accounts, saving for reinvestment and emergencies, and handling cash payments like a pro, you're well on your way to financial success. Remember, friend, being your own boss doesn't mean financial chaos; it means taking control of your money and building a thriving business.

Now, go out there and show the world what you're made of. Trust me, there's no better feeling than seeing that hard-earned money in your bank account and knowing you did it all on your own. Ready, set, pay yourself! You've got this!

And as always, if you have any questions or need further guidance, reach out. I'm here to help you slay the entrepreneurial game. Cheers to your success, my friend!

THIS ARTICLE IS NOT A SUBSTITUTE FOR LEGAL ADVICE AND IS OFFERED FOR INFORMATIONAL PURPOSES ONLY. EVERY SITUATION IS UNIQUE AND YOU SHOULD CONSULT A LOCAL ATTORNEY FOR ADVICE ON YOUR PARTICULAR CIRCUMSTANCES.