How much should I pay myself?

When people go into business for themselves as a Sole Proprietor, they usually comingle the business’ funds. Meaning they are using Business funds for personal items and personal funds for business items.

Sole Prop is the easiest way to start doing business, however, if you choose to setup a Corporation or an LLC, these habits need to change. You and the company are no longer the same. The two of you become 2 separate individuals. The company’s money is not your money, and your money is not the company’s money. So, the question usually after setting up the Corporation or LLC is:

How do I get the money out of the company?

How much should I be paying myself?

What can the company cover?

The Answer is: You take only what you need, to cover Food, Clothing, Shelter, Personal Entertainment, and Insurance. Let the company pick up the rest. The company should be covering things like, Business Trips, Cell Phones, Internet, Home office expenses, etc.

You will never take vacations again. Vacations are not tax deductible, however, business trips are. You will need to make sure that everything is documented.

I will discuss what your company should be covering in another article. Now, usually in the 1st or 2nd years of operation, a business owner has no idea what the company is going to make, so they might take money out as an owner draw rather than a salary. However, around the 3-year mark, the IRS will figure that you have some idea as to how much the company will be making and require you to start taking some sort of salary out of the company.

In addition, if you want your company to cover health insurance, contribute to a qualified retirement plan such as an IRA or Solo 401K, you will need to be drawing a salary from the company. The contributions will be withdrawn by the payroll company out of each paycheck.

Now you might be thinking, if I need additional money from the company, how do I take it out. Well, if you have an “S” elected Corporation or LLC, you will receive distributions on a monthly, quarterly or annual basis. This will add to your income but won’t be subject to withholdings or self-employment taxes. If your Corporation or LLC is taxed as a “C” elected company, you can either take a dividend which the Corporation has already paid the taxes and now you the individual will also pay taxes. This is commonly referred to as double taxation.

However, your company could loan the money to you personally, which is not considered taxable income. You would then pay the company back out of the wages you take. This can be used as an Asset Protection mechanism. The company, just like any other lender could place a lien against whatever asset you may be purchasing. This will protect the asset from any liability that might affect you personally.

This does require a formal written promissory note between you and the company to perfect the process.