Small business owners have several options for paying themselves, and the best approach depends on the legal structure of the business and individual preferences. Here are common methods that small business owners use to pay themselves:
- Applicable to Corporations: If the business is structured as a corporation (either an S corporation or a C corporation), the owner can choose to pay themselves a regular salary, just like any other employee. This salary is subject to income tax withholding and payroll taxes.
- Owner’s Draw or Distribution:
- Applicable to Sole Proprietorships, Partnerships, and Some LLCs: Owners of sole proprietorships, partnerships, and some limited liability companies (LLCs) may take draws or distributions from the business. This is not considered salary and is not subject to payroll taxes, but it also doesn’t have the same tax withholding benefits.
- Applicable to Corporations: If the business is a corporation, the owner may choose to pay themselves through dividends. Dividends are distributions of profits to shareholders. Dividends are typically taxed at a different rate than salary income.
- Applicable to All Business Types: Small business owners can be reimbursed for legitimate business expenses they incur on behalf of the business. This is not considered income but is a way for owners to cover business-related costs.
- Loan Repayment:
- Applicable to All Business Types: If the owner has loaned money to the business, they may repay themselves by treating the repayment as a loan repayment. This is not considered income but reduces the owner’s loan balance.
- Profit Distributions:
- Applicable to Partnerships and Some LLCs: In partnerships and certain LLCs, owners may receive profit distributions based on their ownership percentages. This is a way for owners to share in the profits of the business.
- Combination of Methods:
- Small business owners often use a combination of these methods based on their financial needs, tax considerations, and the structure of their business.
Small business owners should consider the tax implications of each method and consult with a tax professional or accountant to determine the most appropriate strategy. Owners should also ensure compliance with legal and regulatory requirements.
Maintaining accurate financial records is crucial. Proper bookkeeping ensures that the business owner can track income, expenses, and various forms of compensation accurately, which is essential for financial management and tax compliance.