Practically everyone likes to get paid for the work they do. Business owners are no exception, but they must understand that initially it can take a little while to actually make money. Most won’t stay in the business indefinitely if they never see any cash flow their way.
So, once your business actually starts making some money, how can you pay yourself as a business owner?
Payments come in several forms and are dependent upon your business type:
Payroll: This must be a reasonable amount per the IRS and must be paid regularly regardless of profit.
Guaranteed Payment: This is set up in the operating agreement and is taken regardless of profit.
Distributions: These are taxable payments of the retained earnings of a business to its owners.
Draws: These occur when a business owner takes funds out of their business for personal use, and they are not taxable (taxes are paid on total earnings, regardless of whether or not draws are taken).
Check your business type below to see how you can pay yourself.
Making these payments requires planning. Here are a few things to consider:
Make sure you have the cash. We encourage our clients to set aside a portion of each deposit (or simply on a regular basis) into various accounts or “buckets.” We recommend two buckets for most clients related to this issue: one for payroll/guaranteed payments and the other for draws/distributions. These buckets are filled as income comes in, and funds are taken out in a set amount on a regular basis for payroll and guaranteed payments. Dividends and draws are also taken on a periodic basis (perhaps quarterly) but are based on the amount available in the account. It’s a good idea to withdraw no more than 50% of what is in the account in order to keep some savings for the future.
Set aside funds to cover taxes on distributions. Also, consider setting aside taxes for your business’s net income. Remember, any business type except for a C--Corporation has its net profit flow through to the owners/partners. You can take a draw to cover these taxes – but you must have the money available to do so.
If you’re eligible for payroll, make sure the amount is considered reasonable by the IRS. What would you pay someone to do this job if you weren’t doing it? Is your business losing money? This is a good time to have a conversation with your tax CPA to determine what they think the IRS would consider reasonable.
Check your operating agreement. If there are multiple owners, then draws, guaranteed payments, etc. may all be specified as to timing, amount, and purpose. Make sure you follow the agreement to avoid future problems.
It’s important to communicate with your tax advisor to get their input on how often, what method, and how much you should be withdrawing from your business. While there is some room for variability, the tax implications of each need to be understood before you implement this cash stream. If you’re ready to get a handle on your pay and administer your cash flow, schedule a complimentary call with us!
