Deciding when and how to pay yourself a salary as a business owner is one of the more difficult parts of starting your own practice. Many small business owners don’t actually pay themselves during the first few years of business: research actually shows that just over 51% of business owners actually pay themselves a salary. Once your business has a sustained revenue in addition to a steady projected revenue and profits, you may be ready to start getting paid. Paying yourself a salary also means that you can better understand the financial health of your business; you are now able to cover all of your costs, not just the bare necessities.
Now, for possibly the first time in your life, you get to determine exactly how much you get paid. There are a variety of factors that come into play when calculating how to pay yourself as a business owner: your business structure, your business performance, what a reasonable salary actually is, and more. Here, we’ve broken down exactly how to pay yourself based on these factors, so that you and your business can continue to thrive.
Salary vs. Owner’s Draw
As a business owner, there are two types of compensation you can receive. The first is an owner’s draw. In simple terms, this is when the owner takes funds out of the business account for personal use. When starting a business, entrepreneurs are likely to contribute cash, equipment, and assets; this becomes your owner’s equity. As your business grows (or doesn’t), your owner’s equity comes to include your share of the profits and losses. Therefore, if you choose to take an owner’s draw, your draw may not exceed your total owner’s equity. For example, if you contribute $50,000 to begin your wellness practice, and then make $30,000 in profit, your owner’s equity becomes $80,000, and you can withdraw up to $80,000 from your business to pay yourself. There are pros and cons to using this method of payment. Choosing an owner’s draw does allow you greater flexibility; your compensation can fluctuate depending on the performance of your business. However, owner’s draws reduce a business’ equity, subsequently reducing funds available for the business.
A salary, on the other hand, is a set amount of money you get paid every pay period. Obviously, paying yourself a salary has pros and cons as well. With a salary, there is less administrative work; taxes are deducted from your paycheck automatically. Your compensation also becomes a fixed expense, making it easier to budget, and track your income and expenses. However, it’s a bit more difficult to adjust your salary based on business performance, unlike an owner’s draw. While you can change your salary to help the financials of your business, your salary still must fall within the IRS’ definition of reasonable compensation.
So, which method is right for you? Unfortunately, depending on your business entity, the choice of how much to pay yourself may not be up to you.
- Sole Proprietorship: As a sole proprietor, you should pay yourself using an owner’s draw. You will pay self-employment taxes using a Schedule K-1 for 1040.
- Partnership: If your business is filed as a partnership, you must also use an owner’s draw. The IRS does not allow both partners to be paid a salary. You will pay self-employment taxes using a Schedule C for 1040.
- LLC: Because an LLC can be taxed as either a sole proprietorship, a partnership, or a corporation, your compensation will depend on how your LLC is filed.
- S-Corporation: If your business is filed as an S-Corp, you can be paid through a salary as well as distributions. You must have an active role in the business, as an employee, to be paid a salary. It is likely you are a shareholder in the S-Corp as well, so you may also take distributions from the profits of your business. Your salary will be taxed like the rest of your employees (W2), but you will not pay self-employment taxes on your distributions. You will use a Schedule K-1 for 1040 to pay taxes on those dividends.
- Corporations: As a corporation, you can be paid through a salary and dividends. Again, you must be an active employee in the corporation to receive a salary, meaning you have a role like any other employee. You will use the W2 income on 1040 form for taxes. Dividends are a distribution of your company’s profits, and you will use the Dividend Income section on the 1040 tax form.
Healthie’s comprehensive practice management software can help organize your business structure and profits so you can decide which method is best for you. Get started for free today!
How Much Should I Pay Myself? Calculating Your Salary
If you and your business are in the position where you will be compensated through a salary, you are responsible for calculating how much you should pay yourself. There is no perfect formula for calculating your salary, but we can offer a few recommendations for determining an appropriate wage.
There are a few factors to take into account when determining how much to pay yourself as a business owner:
- Business Stage
Your salary can be heavily influenced by what stage of growth your business is at. If you are just starting out, you shouldn’t be using the majority of your profits to pay yourself a considerable salary; rather, you should be taking what you need for personal expenses, and investing the rest right back into your company so you can continue to grow, and eventually pay yourself something more comfortable.
- Business Performance
As the business owner, it is recommended that you pay yourself based on the company’s profits, not its overall revenue. As we mentioned above, your salary can fluctuate depending on your business’ performance and the stage of your business. You must still keep your salary within the range of reasonable compensation, but if you are doing well, you might be able to increase your personal earnings a bit.
- Reasonable Compensation
The IRS does monitor what business owners pay themselves to ensure they stay within the range of reasonable compensation. Naturally, reasonable compensation depends on your occupation and specialty, so be sure to familiarize yourself with the IRS’ guidelines to avoid any discrepancies.
- Personal Expenses
Your salary must be enough to cover your personal expenses and life necessities. Once you’ve calculated these, you can compare against the reasonable compensation and your business’ performance and growth to determine an appropriate salary to pay yourself.
You should also take these factors into consideration when taking an owner’s draw out of your business funds; as we’ve mentioned, an owner’s draw is much more flexible than a salary, so you can consider these factors each time you go to withdraw funds. Be sure to carefully assess the risks of taking out a draw: if you overdraw, you could leave your business with insufficient operating funds and cause large financial and operations problems. Healthie’s platform has flexible membership plans to adapt to meet your business needs as you discover what is right for you.
Healthie for Wellness Businesses
As you grow your wellness business, Healthie is the perfect practice management and telehealth tool to have by your side. Healthie has all of the back-office tools along with a comprehensive client engagement suite, wrapped up into one user-friendly platform.
Healthie supports small business owners with receiving payments, and getting paid:
- Link your personal or business bank account
- Process payments and receive bank transfers directly to your linked account
- No 3rd party payment processor needed
- Advanced reporting for business financials
Healthie’s back office management includes features such as analytics and reporting, scheduling, insurance billing, out-of-pocket payments, intake forms, charting, and much more. You can easily use Healthie to automate the intake process, create seamless workflows. You can spend more time providing your clients with quality care, and less time on the day-to-day operations of a small business.
Streamline your business operations and client management. Get started with Healthie, the all-in-one practice management solution for wellness professionals. Click here to learn how to set up these features with Healthie’s Free Starter Plan today.
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