Handbook / Bookkeeping and cash

How to pay yourself as a self-employed business owner

When you work for yourself, there is no payroll department sending you a salary. You decide how and when money moves from the business to you. Getting this right keeps your books clean, avoids tax surprises and gives you a steady personal income even when business income goes up and down.

It depends on your structure

The IRS explains that the procedures for paying yourself depend on the type of business structure you choose. The main cases are:

• Sole proprietorships, and single-member LLCs taxed as sole proprietorships: owner's draws.
• Partnerships, and multi-member LLCs taxed as partnerships: draws or distributions, and possibly guaranteed payments, according to the partnership agreement.
• Corporations, including S corporations: wages for officers who work in the business, plus possible distributions.

See LLC vs sole proprietorship for how structures differ.

Sole proprietors: owner's draws

If you are a sole proprietor, you and your business are the same taxpayer. You pay yourself by taking an owner's draw: transferring money from your business account to your personal account.

Key points:

• a draw is not a business expense; the IRS instructions for Schedule C say not to include amounts paid to yourself in the wages line
• you are taxed on your business's net profit, whether you withdraw it or leave it in the account
• draws do not have tax withheld, so you must set aside money for income tax and self-employment tax yourself

Record each draw as an owner's draw or equity transaction in your books, not as an expense. See chart of accounts.

Corporations and S corporations

The IRS explains that an officer of a corporation is generally an employee. Officers who perform services should receive wages, subject to withholding, and the IRS says wages should be reasonable for the duties performed. If an officer is underpaid, the IRS may adjust both the corporation's and the shareholder's returns. S corporation owners who work in the business are often paid a reasonable salary through payroll, with additional profits possibly taken as distributions. This is more complex, so get advice from a tax professional. See S corp election and payroll.

Set tax money aside first

Before paying yourself, move a portion of every payment into a separate tax savings account. Self-employed people generally pay income tax and self-employment tax through estimated taxes. The guide to how much to set aside explains how to estimate your percentage.

Choose an amount

A simple approach:

1. Look at your average monthly profit over several months.
2. Subtract the tax percentage you set aside.
3. Keep a cash reserve for business costs and slow months.
4. Pay yourself a regular amount below what remains.

If income is irregular, pay yourself a steady "salary" from a buffer account and top up in good months. See irregular income budget.

Pay yourself on a schedule

Regular draws, such as on the same day each month or every other week, make personal budgeting easier and help you see whether the business is truly supporting you. Avoid dipping into the business account whenever you need cash; it blurs your records and makes cash flow harder to manage.

Keep accounts separate

Use a separate business bank account and pay yourself by transfer. Avoid paying personal bills directly from the business account; if you do by mistake, record it as a draw. Separate accounts make bookkeeping, tax and, for LLCs, liability protection easier. See bookkeeping for the self-employed.

Profit first habits

Some owners use an allocation approach: each time money comes in, a set percentage goes to tax, owner's pay, profit savings and operating costs. Whatever method you use, the key is deciding in advance rather than paying yourself whatever is left.

Review regularly

Review your pay every quarter. If profits rise consistently, increase your draw. If they fall, reduce it before the business runs short. Your profit and loss statement is the place to start.

Know how your structure works: sole proprietors take non-deductible owner's draws and are taxed on profit, while corporate officers take reasonable wages; set tax aside first, pay a steady sustainable amount on a schedule and keep accounts separate.