Most small business owners never actually sit down and decide how much they should be paying themselves, or on what schedule.
Some months, business is solid, so you move yourself a good chunk. Other months it’s tighter, so you take less, or skip it. There’s no fixed number behind it — just a read on the balance.
Uneven cash flow is a common reason for this fluid approach to owner compensation. When money doesn’t show up on a predictable schedule, paying yourself “whatever feels safe this month” is a pretty understandable response.
But a lot of owners feel vaguely uncomfortable with a monthly gut call and ask themselves: Should I be on a salary or take draws? And how much should I be taking out, anyway?
It’s your money
There are good reasons that you might want to take a salary vs draw or the other way around. Or you might want to leave money in the business. But at the end of the day, you’re the owner and it’s your money so you get to decide the how, when and why. If you want or need the money, take it.
Salary vs Draw – it’s about the taxes
You should only be taking a salary if, in consultation with your tax provider, you’ve made an S-corp election. When you make that choice, you will also set a reasonable salary. This is the maximum amount you want to take as a salary. Everything beyond this, you should take as a draw.
If you didn’t make an S-corp election, then everything is a draw. This doesn’t mean it can’t be a regular amount that comes out on a set schedule – just that it won’t be paid through a payroll company.
The obvious follow-on question is whether you should be an S-corp. This is a topic for an upcoming newsletter, but as a preview, when you have at least 6 figures of money to take out of the company, there are some tax advantages to doing this. Give us a call and we can walk you through a more detailed analysis.
Either way, set some aside
If you’re taking a salary, there are some taxes withheld. If you’re taking a draw, there aren’t. Either way, there are additional taxes that come into play, so don’t forget to set aside funds for April 15. We’ve talked in the past about estimated payments, but whether you make those or not, just because you can take out whatever you want, doesn’t mean you don’t still have to remember the tax man.
A starting point for “how much”
Your books already have the answer, or close to it. Pull your net income for the last twelve months — after expenses, before anything you’ve taken out — and average it. That average is roughly what the business can actually support paying you, month over month, without borrowing from next month to cover this one.
From there, most owners land somewhere below that average, not at it — leaving some room in the business for the slower months, not just the ones you’re looking at right now.
You can switch things up
You can skip a payment, take an extra payment, pay yourself a bonus – even contribute money back into the company if you take out too much. Don’t be cavalier about that last one without talking to us first, because it can have some bad tax consequences if you do it wrong, but the point is that nothing is written in stone.