No matter whether you are just getting started in business or are a seasoned business owner, you need to revisit the method by which you are paying yourself. Perhaps, in the initial days of your business, you went through a period of time where you paid yourself only if there was a surplus in the business accounts. However, as your business matures and as cash flows become more predictable, you must gain control of your withdrawals. You need to plan the method and how often you pay yourself from your business.
Before I go any further, I want to remind you that I’m trying to simplify complex financial matters. I may be leaving out some information specific to your individual need. Therefore, visit with your CPA and CFP® because they can give you further guidance about this particular topic.
Did you know that the structure of your business, its entity selection, actually dictates how you get paid? Let me explain.
If your business is structured as a C Corporation, an S Corporation, or an LLC taxed as an S or C Corp, then you are probably getting paid a salary. You’ve filled out a W-4 form, and you’re actually getting a paycheck and a W-2. You are having payroll taxes withheld, and the company is matching your FICA, FUTA, and SUTA, depending on your state of residency. Nevertheless, you are getting a paycheck.
On the other hand, if you are a sole proprietor, a partnership, or an LLC taxed as a sole proprietor or partnership, then you are probably paying yourself an owner’s draw. If you aren’t receiving a W-2 or paycheck, then you are probably receiving a K-1, and you have to deal with self-employment taxes. In 2019, those taxes are roughly 15.3% of the first $128,400 you make. Since you aren’t having payroll taxes – FICA, FUTA, SUTA, Social Security, and Medicare – taken from a regular paycheck, then you’re probably making quarterly estimated tax payments depending on how your CPA or bookkeeper has you set up with the government.
Now, if you are paying yourself on a regular schedule, your income could be considered a “guaranteed payment.” In other words, it’s guaranteed regardless of how well or poorly your business performs at any given time. However, if your owner’s draw is directly tied to your company’s profits, then you are probably receiving what’s called a “distribution.” Distributions are generally made relative to company earnings, whereas guaranteed payments are made irrespective of earnings.
If you are operating your business as an LLC, then you have some flexibility on how you get paid. Yet, you have to be careful because you don’t want to misclassify the type of payment you’re receiving. Why? Because under the new tax code, guaranteed payments are often not included as part of the QBI Deduction. That Qualified Business Income Deduction is potentially a 20% deduction on the income your company makes. Additionally, if you aren’t getting a salary or taking guaranteed payments from the company, then your retirement planning decisions also vary.
So how you pay yourself really does matter. If you are not sure what’s best for you and your personal tax plan, reach out to your business planner, your financial planner, your retirement planner, and/or your CPA. Don’t be afraid to ask for professional help. Comprehensive wealth planning (holistic business and personal financial planning) matters more than you know.
I want to emphasize the fact that you NEED to ‘pay’ yourself. Ideally, you want the amount you pull out of the company to match the amount you’re spending in your specific personal budget. You don’t want to pay yourself more than you need. But you also don’t want to pay yourself last. Regardless, you want to have enough cash in your personal accounts to float you through emergencies or through unexpected expenses. You don’t want to live paycheck to paycheck. But how do you do that?
Now, you have an emergency fund. Congratulations! You’ve moved from paycheck to paycheck, and now, you can determine how often you need to pay yourself from your business. If your budget dictates that you need to pay yourself weekly, biweekly, or monthly, do so. Just make sure you pay yourself so that you can stay afloat.
In the next article, I’ll talk about how much money you should ‘pay’ yourself. Let’s continue to make our lives, at least, financially simple!