As a Business Owner – Salary, Draw or Both!
When looking at a balance sheet, there are a few ways an owner can receive compensation at the end of the day.
How to go about this should involve an accountant and an attorney who is on the payroll or ones that are entrusted to give sound advice.
Depending on the structure of the company, the owner might be limited to the ways they are able to bring in a personal income from the business. Uncle Sam has regulations in place for owner compensation which is different as a sole proprietor, to a partnership, or to being incorporated or an LLC.
One way for a business owner to be compensated is with a salary.
This method includes the owner to pay employee taxes and employer payroll taxes. However, if you are an S-Corp or C-Corp, you do not have a choice and must receive a regular salary. If you are an officer of an LLC, which most owners are, then this method also applies. The company’s legal and accounting team will be able to determine the limits which best suit the business so not to overtax the owner.
Regardless of the business type, a salary has other benefits that are not directly related to the money received. It is one way to separate personal and business finances. This keeps the red flags down so Uncle Sam is less likely to audit from irregular cash flow. It can also help to regulate smaller businesses and be a source to offset other expenses. Another benefit to taking a salary is when the time comes for a business transfer or taking out a business loan. Especially if the compensation is comparable to a position the owner is doing in place of hiring an employee, this will allow EBITDA calculations to be easily obtainable in this respect.
Another way for a business owner to be compensated is with an owner’s draw.
For sole proprietors and partnerships, this might be the only way they receive compensation in the beginning. When growing a business, it can be difficult to factor in a salary too. However, when taking an owner’s draw, regular payments are still a good idea for the same reason as with a salary. Unwarranted audits are hardly welcomed, especially if they are easily avoidable. A simple way to calculate a draw is to gather the common personal bills and business receivables that can also be logically documented. These can include shareholder distributions, auto expenses (insurance, gas, loan payment), insurance and medical payments, and cell phone bills to name a few.
What about both?
When taking a salary, additional compensation in the form of a draw is also possible.
The right calculation for each company will vary. There are tax implications for each way of handling how compensation is received. Taxes are owed on profits and revenues which is where the draw is coming from, and taxes are owed on salaries in the form of employee taxes and employer taxes. Bring in the company’s legal and accounting personnel to answer what these implications are as they will be the ones handling the questions once tax time comes around. Knowing the entrepreneur salary options is the first step, having a solid team of business advisers is the safest step.
For further reading that asks all of these questions and more is, The Entrepreneur Salary: How Much (and When) Do You Pay Yourself?