How To Pay Yourself When Self-Employed
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When you’re self-employed you probably want to get paid.
So you think you should pay yourself.
At least a little somethin’, amirite?
You are the business owner after all!
I mean, you do have bills to pay.
Unless you live with family or are taken care of I guess!
But let’s stay on point here lol.
How do most people take money out of their business for personal expenses?
By writing a check and taking it to your financial institution to deposit.
Or doing a mobile deposit.
Or simply transferring money whenever they need it.
Some people I have worked with have made transfers as many as 3-4 times a week.
That is a horrible way to pay yourself no matter how you look at it, but not uncommon.
Why?
Because, just like anything else, there is a right way and a wrong way to get money out of the business to take care of personal expenses.
And just to be clear, when I say “pay yourself” I’m using that to describe the act of taking money out of your business to use for personal purposes.
The Problem With Taking Money From A Business
The money that comes into a business is meant to be used strictly for business purposes.
That means it can only be used for paying for:
- supplies
- business rent
- running payroll
- marketing costs
- your business website & all its related costs
- and anything directly related to the operation of the business.
That money is not to be used to pay for your:
- mortgage payment
- grocery delivery services
- utility bills
- car insurance premiums
- anything for your kids
- personal vacations
- or anything else that has nothing to do with the business.
If you work from home, you can take a reasonable portion of certain household expenses such as phone, power, cable television & internet, or auto-related outlays.
Sometimes, however, it is necessary to take money out of the business in order to cover some personal expenses…
The Wrong Way To Pay Yourself
Lots of people who own small businesses don’t know how to properly handle the task of taking money out of the business.
Unfortunately, many also don’t feel like they need to work with a tax accountant because they can “Google what they need to know”.
They simply make payments for their personal expenses out of the business bank account or use the business credit card for those personal expenses.
Some even head over to the ATM machine and take cash out of the business for no other reason than to have some pocket cash.
None of those methods are even close to proper.
Another thing I’ve been hearing as of late is incorrect advice for sole proprietors and single-member limited liability company (SMLLC) members, or the partnership partners to sign up with a payroll service and take a salary.
While in theory that’s a sensible option and helps to alleviate the headaches of paying self-employment tax each quarter, it’s not permitted.
A sole proprietor can have employees but they cannot be employees.
If anyone recommends that you pay yourself by putting yourself on salary as either a partner (of a traditional partnership without S Corporation status) or a sole proprietor you should ignore them and seek advice elsewhere!
The Correct Way(s) To Pay Yourself
Let’s face it, starting a business wasn’t done just to put in work and get no reward.
You want to get paid for your time and effort.
If you need to access money for personal reasons, there are three acceptable methods for doing so:
- Putting yourself on salary and taking payroll checks (if an S-Corp)
- Writing a check to yourself in the form of a distribution (again, if an S-Corp)
- Schedule regular draws (if you’re a sole prop or Single-Member LLC) instead of random withdrawals
You should always create some sort of separation between business and personal expenses, and taking either of these steps does so without drawing any unnecessary attention to the transactions.
Setting yourself up with regular payments, even if they aren’t actual “salary” checks helps not only keep the business looking legit, but it also helps people budget better because it simulates a regular salary like before they took on the entrepreneurial venture.
It also creates a paper trail, which keeps you in a good position if/when it comes to…
Getting In Trouble By Not Paying Yourself Properly
So what’s the worst thing that can happen if you don’t keep your business and personal money and expenses separate?
If you continue to treat your business as your personal piggy bank?
Bottom line is that if you are ever looked at for any reason by the IRS, a whole lot actually.
The first that that would happen is that you would have to undergo an audit, during which the burden would lie on your shoulders to prove that the expenses in question are valid business expenses.
It is your responsibility to show proof in the form of receipts or invoices that can support your claims.
If you cannot, then the fun really begins.
If you happen to be a C-Corporation, then the tax return would be recalculated with all of the expenses added back.
What makes this particularly troublesome is that C-Corps can be taxed at higher rates than individuals.
Not only that but you will be assessed interest and penalties on the unpaid portion of the newly calculated tax liability.
If the business is a partnership or an S-Corporation, the expenses will still be added back to the tax return, but it gets a little dicier from there.
Since those business formats flow through to the personal income tax return, you not only have to have your individual return recalculated but the additional income may in fact cause you to be phased out from deductions and/or credits that were originally claimed.
Let’s also keep in mind that if you have a state income tax, your state return will be affected too.
From there, your new income tax liability will be computed and you will again be charged penalties and interest on the unpaid portion of this new figure.
Additionally, you will now be on the IRS’s radar and the chance for future reviews and audits will increase.
On top of that, if you needed to raid the business accounts to support your personal lifestyle, then you will be in even greater trouble once the interest and penalties start piling on.
“How Much Should I Pay Myself?”
This is something I get asked regularly:
Hey Eric, I’m newly self-employed, can you tell me or help me to figure out how much I should pay myself?
Dozens of entrepreneurs
It’s not a bad question.
In fact, it’s a sign that they are thinking about things in the right way.
The answer, however, is difficult to come by.
It’s like most things in life, the answer is: it depends.
Everyone has a different circumstance and family situation to consider when coming up with a figure to pay yourself.
Another thing that factors into the equation is whether the business is profitable or not.
Obviously, if your business is losing money, you can’t pay yourself.
The best way I have found to answer the question of “how much should I pay myself” is to do this:
- Make a budget for your personal needs
- Figure out how much in total you will need to pay yourself in order to meet the budget
- Divide that number in half
- Pay yourself one half on the 15th of the month
- Pay yourself the 2nd half on the last day of the month
This essentially acts like a regular paycheck which makes it easier to maintain a budget.
If, however, you can’t pay yourself that amount in full, then simply pay what you can.
The point of this exercise is to make it so that you aren’t constantly dipping into your business money to pay for your personal expenses.
So now you know the answer to the question “How much should I pay myself?” should you be wondering?
Wrapping Up
Well, that’s the basics on how to pay yourself as a self-employed “boss”.
Granted, no one article can ever address everyone but this should help the majority of you.
Keep in mind 2 things:
- Nothing is written in stone–you can schedule it however and use any dollar figure you wish.
- These aren’t “rules” or “laws” just guides to help keep you out of potential trouble and make it easier to manage your business plus your money.
I urge you to adjust these guides to suit your own individual situation.
And one last thing:
A BUSINESS IS NOT YOUR PERSONAL PIGGY BANK!
Your Turn
How do you pay yourself as a self-employed person? Do you just take money out of the business account whenever you feel like it? Do you have a schedule? Do you leave the money in the business account and simply pay yourself whenever you want to bring that balance down?
I have an LLC and I am giving myself a monthly salary, plus a year-end bonus. I need a vehicle now and can’t wait for the bonus time. Am I allowed to collect the bonus early to take care of that need?
Hello Bernadette!
When you say “salary” do you mean regular pay with all of the taxes withheld? In general, LLCs don’t pay an actual salary unless they are being treated as S-Corps which is why I bring this up.
If it is an actual salary, you can give yourself a bonus at any time for any reason. It doesn’t have to be calculated in any particular way or paid on any specific date. You can even run multiple bonus payroll cycles throughout the year.
We are a fairly new S-Corp with a profit last year of $50,000. There are two shareholders, myself & my partner each 50% ownership. If we were to take distribution checks this year, is the maximum amount $50,000 between the both of us? ($25,000 each).
Also, are profits of a S-corp taxed ?
Let me answer the second one first, Dan.
The S-Corp profits are not taxed to the business, but pass through to the shareholders to be included on their individual income tax returns. You are paying the tax based on your share of the profits and your personal tax rate.
The first question isn’t as cut and dry as it might seem. There are a few variables that go into the question of “what can be distributed”. you would be best served using the link at the end of the article to schedule time with me, since there is more information needed to accurately and completely answer this particular question.
Hi,
I’m the business operations coordinator/HR/AR/AP/whatever else they have me do. The owner of this company has direct debits for personal expenses (His health insurance, car payments, insurance). He also hand writes checks to pay for personal things, and also uses the company debit card for personal purchases for anything from dinner with his family to vacation purchases and a generator for his house.
I’ve gotten him to raise his salary, but he still does this. I’m responsible for keeping our books. (Using QB online).
He’s not going to stop this, so for the time being, how do I record these personal expenses in QB? I don’t know what category to put them in, or what to do about these.
Thanks for reading Lauren!
Anything personal should be classified as “Owner Draw” or “Shareholder Distribution” depending on the business structure. So, instead of hitting an expense account, the debit will go toward their equity account instead and not be reflected in the P&L.
If you need more in-depth and/or specific assistance, please feel free to schedule some time with me: https://clarity.fm/eric-nisall
I am a one-person S Corporation in the advertising/media planning & buying field. I live in and run the business out of my partner’s home, rent-free. My corporation is being audited by the state. My home office is my ONLY office and is used exclusively & regularly for my business. The auditor is not allowing any business-related/business supply deductions (this includes things such as an electric pencil sharpener, a desk lamp, Quicken Business software, a business laptop battery, a business cell phone charger, etc.), however, because I do not pay rent and do not have a written arrangement with my partner to this effect. He says I have no valid arguments because of this. He is also disallowing any deductions for internet or TV (both ordinary and necessary for my particular business and field) or client-required product research/online software purchases for this reason. He also says that these latter costs are not reasonable costs under the IRS Research & Experimental Costs definition since they are “advertising or promotions” (which is what my business does). This seems extremely strange to me. Am I crazy?
Hello SRD.
For starters, the home office deduction isn’t available for S-Corps. In that situation, you would need to draw up an accountability arrangement to pay whoever it is that provides your rent & utilities a fair and set amount per month and then pay them from the business account. Since you don’t pay rent, and I’m assuming you don’t pay for the utilities either(?), then you have no standing to claim any household expenses as business expenses.
As for the other expenses such as office supplies and computer programs, I have no clue why those would be denied. Unless you are unable to prove that you are using them specifically for business purposes which is a very big issue when people use personal items in business.
I would suggest you hire a tax attorney or CPA who is experienced in IRS representation. That is by far your best option.
Hi Eric, the owner of an S-Corp with 20+ employees is on payroll with a high six-figure salary. In addition to that, they run about 50-60% of personal expenses through the business (clothing, vacations, groceries, home renovations, entertainment, cable bills and the list goes on), additionally they take personal distributions throughout the year, support a second and separate business at times through this company and have personal staff non-company related on the payroll. One of the top executives has a profit share agreement, what he has come to learn though based on the personal compensation of the owner is that the profits are being depleted through the years so technically he hasn’t received the actual % of profits as it’s been considerably lower by the time the end of year comes around. Is this illegal or considered misppropriation of funds in any way? Does this employee have a case or argument especially in light of the business struggling the last 2yrs, layoffs occurring and the owner continued in the same way? Any advice you can offer would be appreciated.
Hello, I have a question. I work for a very small company and my boss is the Director of Operations. The owner of the company is rarely here and doesn’t know anything about what’s going on, because my boss approves all expenses. My boss uses his personal credit card for both business and personal expenses. For example, a $5,000 trip to Alaska, flooring for his new home, blinds for his new home, granite countertops, ATV rentals while on vacation, clothes, groceries, I could go on and on….. How do I handle this situation? I don’t want to lose my job, but I also think the owner should know. It’s getting absurd.
Hello Sarah.
I’m sorry you’re in a bad working situation. It’s never fun when you realize that your boss isn’t doing things the right way. Unfortunately, I really don’t know what to tell you, other than to maybe try to get word to the owner very quietly to “drop in to check on things” related to the books.
It’s much worse if your boss is trying to use the business card for his personal expenses and write them off through the business. It’s not quite as bad if he uses the personal card for everything and then gets reimbursed for the actual business expenses, even though it is still wrong.
I am a new business owner, and I have my company structured as an LLC and Scorp. I am 100% percent owner. My question is I was reading in your comments that you recommend doing owner distributions or owner draws and top of that paying a salary on payroll? Am i understanding this correctly? Can I just do Owner draws monthly or twice a month as my salary instead of being on payroll? On top of running this business i also have my full time job.
The short answer is NO. As an S-Corp you are required to take a reasonable salary as stated by the IRS. There isn’t a firm amount as to how much but accountants have widely used the “60-40 Rule” which means 60% of compensation from salary and 40% from distributions.
You can absolutely not take it all or predominantly as distributions.
If you don’t want to be on another payroll, you can elect to revoke the S-election as of Jan 1, 2019–I always recommend using the beginning of the year for any changes due to the clean year-end break.
That’s pretty much all I can provide you with in this type of forum. If you need more personalized service, I suggest you book some time with me to dive deeper into the issue at https://clarity.fm/eric-nisall or find another professional, but it would be best to speak with someone who has the background to deal with this type of thing and not some random person on a social media group or other sites where you cannot verify the qualifications.
Hi,
I am a small business owner (LLC/S Corp) that operates the business from my home (one room turned to studio/office) and I pay myself through payroll system (I get taxed each payperiod). Currently, I am using money from my business to pay for supplies/marketing/business travel,etc. however I wondered what else could I use money from the business for? I’m wondering about things like internet, phone, partial mortgage, etc..I’m based in California (if that matters).
Thank you in advance!
Hey Gilbert!
What you’re looking for is either a course to teach you about running your business in terms of the bookkeeping which you can find at http://bookkeepingforbloggers.com or personal consulting services which I can provide if you make an appointment at https://clarity.fm/eric-nisall.
I work for a boss who has a few companies. We have one big company that pays for products. She has a tendency to take payments from client A through Company 1 and pay off her personnel loans and business loans which she is then booking against Company 2 which has another investor. She also takes money from client B and uses 80% of to pay off the work that was then suppose to be done for client A and more of her personal expenses. Falling behind on payments for client B’s projects. These are all different companies she is moving the money through.
Client A is paying for projects to be done annually and she has now drawdown for projects that aren’t starting for months but she has spent 50% of the funds need to complete the later work. What little books there are seem to be co-mingled and it appears that she is double claiming things in taxes.
She thinks all this is fine. Is it? or are there laws being broken here?
hi my husband wants to add me to his business bank account but I am not a partner nor do I work for him is this advisable for tax purposes
Hello Eric,
I am the owner of a custom cabinet and general remodeling S Corp. 4 employees.
Can I personally contract my own business to renovate an old farmhouse I purchased personally? Pay the S Corp a fair and profitable price from my personal funds?
Company would write off payroll and materials but take in payments to show a real and reasonable profit in line with what the company sees in its other contracts.
Hey Ray!
I have seen people do that exact thing, and as long as it’s on par with your normal rates then there shouldn’t be a problem as long as you treat it like any other job with estimates, invoices, deposits, etc.
I have a sole proprietorship business and I want to take a draw to pay for an e gift card for my spouse. Would it be okay to transfer the amount to PayPal to pay for the card and make a note on the transfer from my business to PayPal, “ owner draw” .
Sue
Loved this article! Very informative and a lot of things that my coworkers and I have been noticing – a lot of spending on company card for vacations, nights out and personal expenses – took himself off payroll so he could actually just spend what he wants, now the best part – we are off the books and cannot pay taxes because he cannot “afford it” so he’s been just paying us under the table. Very frustrating 🙁
I know a CEO in a nonprofit company that pay his wife repair computer with the nonprofit company money, also his water bills, hotel is ok company pay because the seminaries, but his drinks and take his entire family, I don’t think so the nonprofit company should be pay for that, he hired a new COF, he does anything what CEO tell him to do, they don’t want nobody else do payables, and now I know why, is any places or organization we can let them know what is going on without me getting involve, I just don’t want have problems in the future when looking for a job.
Hi,
Thanks for this article. I have a couple of questions – I’m a new LLC and S Corp (once the government reopens). I am the only member. I want to set up an account to put some percentage of the money coming in aside for taxes. Can this be a personal account or should it be a second business account?
Secondly, I want to use a credit card that is not labeled “business credit card” but it would solely be used for business expenses. How do I pay this? Would I expense the credit card bill, write a check to myself, and then pay the bill out of my personal account?
The previous owners (also my parents) were sole proprietors so a lot of the things they did I’m finding I cannot do as easily.
Thanks!
Well, the first thing is as an S-Corp you should be on a regular payroll–not just taking money out, but rather the actual thing with impounded taxes and paystubs, W-2, etc. If you aren’t then you should get started immediately since that is a requirement of running an S-Corp. I suggest using Gusto and ALL my clients love it…I even use it for my own payroll.
If you want to hold back extra money in saving specifically for the pass-through income, then you can absolutely use a personal account for that. Since you pay those taxes on your personal return, it’s the perfect way to save if you use a personal, high-yield account.
Regarding the credit card, there is a reason they have “business” cards: you need to have the card registered to the business. By using a “personal” credit card, it’s in your name and theoretically you could be viewed as commingling personal and business funds which isn’t a good thing…better to just keep business stuff in the business name/EIN and your personal stuff in your name/SSN.
Thanks for the quick response. Yes, I am taking a paycheck so that is good! It sounds like the main point for sure is business is business and it isn’t personal! I will keep that in mind for the credit card as well. Thanks again!
That’s the point of this article–keep everything separated and your life will be less stressful! 😀
I have recently started a new LLC business. I know I have to pay sales tax monthly on all sales. My question is if I put all the sell money in a business account and I don’t take any draws or payroll money from the business account do I still make any federal deposits on the money in the business account? The reason for not paying myself is that I would like to build the business account up, pay business expenses and when there is enough money to pay me a salary then I will start paying myself. Until that time comes do I pay taxes on the money in the business account monthly?
I have always received a w2 and now I will be going into a field where they want me to create a business but I don’t know which one to pick
Hi Eric, if I made a wire transfer on behalf of my company with my personal checking account, can I expense the wire transfer fee and get a reimbursement?
You can pay yourself back from the company account, and it would be perfectly legal, but you should make every attempt to avoid mixing business and personal funds. If you can’t avoid it, I’d put the money into the business account as a loan, and send the wire from there. And if it’s a large enough sum that will take more than a year to pay back, you need to draw up a contract and charge a fair amount of interest.
I’m a managing member of a multi-member LLC (2 members). Periodically I use the business credit card for personal expenses. I pay for those expenses directly to the credit card company from funds from my personal account; not the business account. This clearly identifies the expense as personal. Is there anything illegal about doing it this way?
Just because it’s not “illegal” doesn’t mean it’s not wrong.
The point of creating an LLC is to have a legal entity separate from the individual members (owners including yourself). That means you should be using the business resources–cash, credit–for business purposes and not personal. If you need money to cover personal stuff, you should be taking a draw, nice and easy.
It will help keep the lines from being blurred in case of legal actions or IRS inquiry.
Hi Eric ,
I am Realtor and the sole proprietor of my S Cooperation. What is the best way for me to pay for my living expenses such as rent , groceries , travel, entertainment and daily costs of living. Is it better to just take out an amount every month to add to another personal checking account or continue to use my business card ? I dont have anyone else its just me.
If you are an S-Corp then you MUST take payroll–actual payroll meaning like with withholding and everything. That is how you should be taking the majority of your money. If you haven’t then you really need to get on that ASAP. I recommend using Gusto as they make it a breeze to manage.
If you aren’t an S-Corp but a sole proprietor, you should calculate a budget and divide it in half, taking one half on the 15th and the rest on the last day of the month to simulate a “salary”. But it should be transferred to your personal account first.
Regardless, you should never be using your business assets to fund your personal life.