You started your business to make an income, whether it's on the side or your full time income to replace a corporate job, you are in business to make additional money in your life to pay for your life expenses and enjoy your life even more.
So why would you not make a plan to pay yourself on a regular basis?!?
You may have researched, or heard, that the recommended percentages of allocating your business income go something like this:
- 50% reinvest back in the business
- 30% pay your salary
- 20% towards taxes
But truth be told, not all businesses can use these blanket percentages.
These percentages don't take into account your personal financial situation.
They don't take into consideration what you are making money for in your business.
They also don't take into consideration how much you need to pay in taxes based on your country, or your state, or even your financial situation.
These rules were developed by people who believe that everyone has the same race, class and gender privilege as them.
These rules were developed by people who don't consider different life situations or financial situations.
These rules were developed by people who believe that you are born to get a job, work for you whole life, then retire and enjoy what you have left. They don't care about enjoying life now.
And enjoying life now is most likely what you started your business.
They have a very specific financial experience that not everyone else shares.
There is No One Size Fits All Formula for Paying Yourself
There is no one size fits all formula for businesses to fall into with using percentages to pay yourself from your business.
Maybe you are in a stage of life where you need all of the extra money that your business makes to pay off your debt.
Or maybe you are in a stage of life where you are looking to buy a house and you are using the profit from your business to cover the cost of the house.
Or maybe you don't need more than the minimal amount of money and you want to grow your business, so you invest heavily in your business.
You have to figure out what works for you.
But let's break this down a little bit more.
Set Up Automatic Payments and a Regular Pay Schedule
First things first, you have to set up automatic payments and a regular pay schedule from your business to your personal account.
If you haven't already checked out my article on having separate bank accounts, go read that before you go further.
You really don't want to commingle your business and personal funds. It gets messy and confusing and you will most likely miss out on some of your expenses.
Your business is meant to pay you a salary that you would earn just like if you were working for someone else.
Set it up that way.
It doesn't matter if you pay yourself on a weekly basis, biweekly or monthly, but create a pay schedule where you pay yourself on a regular basis on the same day of the week or same day of the month.
Pretty much all banks have the ability to set up recurring payments to someone these days, so just set up the payment in your bank account to go from your business bank account to your personal bank account.
Not only is this pay schedule easy for your business bookkeeping, but it's also easier on you and your personal finances because you know when to expect a regular payment from your business to be able to pay all of your bills on time.
It will also make your bookkeeping much cleaner as well.
Also check out: Do I Need Separate Bank Accounts for my Business?
Your Pay Should be Intentional
You shouldn't just be picking a random number out of the air when you decide how much to pay yourself.
There are few things that you need to consider.
What is your personal budget? How much money do you have to bring home as your net pay to make sure all of the bills are paid?
How much money do you want in your savings for both personal and business?
How many weeks of vacation do you want to take from your business this year?
How much money do you regularly need to save for taxes?
How much debt do you have to pay off, personal or business?
How much money do you want to reinvest into your business?
Like I said, you really can't just pick a number out of the air for what to pay yourself. There has to be some figuring out that happens.
Sole Proprietor versus LLC versus S Corp versus C Corp
As a sole proprietor, like I said in the Having Separate Bank Accounts, it really doesn't matter if you end up paying yourself and your personal expenses from your business bank account in the legal sense.
But you really should separate them.
Legally you can just have all of your business funds go through your personal bank account and commingle everything when you are a sole prop.
But this will be a bookkeeping nightmare, as well as an audit nightmare.
Save yourself the time, aggravation and hassle and just separate everything from the very beginning.
As an LLC, you have to have everything separate or you lose the liability protection that an LLC provides.
This also means that you have to pay yourself from your business bank account to your personal bank account. You can't pay your personal expenses as pay from your business bank account.
Yes mistakes happen, but don't let them happen that often.
The same goes for an S Corp and C Corp, you must have all personal and business completely separate.
Believe me, an auditor does not like going through your personal expenses when they are looking at your business anymore than you enjoy it either.
Save yourself the time, aggravation, and frustration and just separate them all from the beginning.
Recording Your Pay in Your Bookkeeping
When you record your pay in your bookkeeping program, as a sole prop or an LLC, it won't show up as an expense. It won't show up on your income statement at all.
You will pay taxes from your business before you pay yourself in this situation.
Your pay will show up as an owner's equity draw or withdrawal.
As an LLC with the S Corp election, an S Corp or C Corp, you will record your owner's pay as payroll expense and your payroll taxes as payroll tax expense as well.
Again, this depends on how your business is structured: sole prop, LLC, S Corp or C Corp.
As a sole prop or LLC, you would pay taxes on your net income in your business.
An an LLC with the S Corp election, an S Corp or a C Corp, then you will pay payroll taxes on your pay.
You are in control as the business owner (and as long as the business has enough money) to pay yourself a salary that you want to receive.
What this means is that you can also do the payroll formula backwards, unlike at a corporate job.
So if you want to receive $2000 a month from your business, then you would give yourself $2000 a month. And do the formula backward to get the amount of tax that would pay for payroll taxes. <- This only applies for LLC with S Corp election, S Corp and C Corp where you receive a payroll paycheck.
You would then take the $2000 and figure out what your gross pay is to get the taxes that you would pay (i.e. federal tax, social security, medicare and state and local taxes) to get you to a $2000 net pay paycheck.
Also check out: How to Avoid a Huge Tax Bill When You are Self-Employed
Finally take your taxes from frustration, chaos and confusion to calm and organized.
Learn everything you need to know to master your business finances and taxes explained in plain English.
Figuring Out How Much Money You Need
Like I said in the beginning of this article, there isn't a one size fits all formula for paying yourself.
BUT there is a formula for figuring out how much money your business needs to make, in order to pay yourself the amount of money that you think should be your paycheck.
And this formula is where you will regularly make adjustments in your business.
Here's what this formula looks like:
Revenue minus expenses equals net income
Net income times the tax rate equals estimated tax due
Net income minus estimated tax due equals the amount of money you have to split between your owner's pay, your business savings and debt payoff for your business
Your owner's pay will include your personal goals of paying off debt, paying your bills and building your savings
You have full control over the numbers that get plugged into this equation.
You may need to take some time to make adjustments.
Where do you need sell more?
Where do you need to reduce your business expenses?
Where do you need to reduce your business debt?
Do you need to adjust your savings goals?
Are there less expensive alternatives out there to some of your business expenses?
In your personal budget, where do you need to make changes?
What if I Want to Give Myself a Bonus?
Go ahead, give yourself a bonus.
If you have a sole prop or an LLC, then your bonus would just count as owner's pay and you would pay taxes from your business before you pay yourself. This would still be classified as a owner's withdrawal in your bookkeeping program.
If you have an LLC with the S Corp election or an S Corp or C Corp, you would give yourself a bonus through payroll and pay the proper payroll taxes. It would also show as a dividend on your income statement and not payroll.
But if your business has more than enough money to pay you a bonus at the end of the month or quarter or year, go ahead and pay yourself a bonus.
Don't give yourself a bonus, though, if your business doesn't have the means to give you a bonus.
Paying Yourself is Still Important in Your Business
It is important to pay yourself in your business. I'm going to assume that's why you really started your business in the first place - to make extra money (or your paycheck) instead of having to work for someone else.
But there are more things to consider when you pay yourself than just giving yourself a paycheck.
What questions came up for you around paying yourself that I didn't already answer?
Read next: Tips for Organized Small Business Finances