One of the biggest questions I hear from Solopreneurs is how should they pay themselves?
If you are operating a single member LLC, as many of you are, paying yourself is one of the easiest things to do (but at the same time one of the most complicated aspects to owning your own business).
There are taxes to consider, what is “reasonable”, how much should you leave in the business to pay expenses, etc.
However, one of the benefits to forming a single member LLC is that it is so easy to pay yourself. Here’s the long and short of it.
- Pull out a check.
- Write the check to yourself for an amount you want to get paid.
- Deposit the check in your personal bank account.
Yes, it really is that easy.
Here’s a video I threw up explaining this in a bit more detail:
But Shouldn’t I be Paying Myself a Salary?
Absolutely, you should decide what your “salary” will be, and then that is what you pay yourself. However, when you are first starting out in your online business, payments may be sporadic or sometimes even non-existent.
Then you do a launch and you get a huge influx of cash.
Now what? Do you take it all out as salary? Invest some back into the business?
It can get complicated.
So here are my recommendations…
How to Figure Out How Much to Pay Yourself
I recommend that you start to get into a regular routine with your business. Paying yourself is just like any other system you have – you want to make this dead easy to figure out (and defend if anyone ever decides to sue you).
There are two options –
- A straight salary.
- A percentage of gross income.
When you are just starting out, since income is sporadic and non-regular, taking a percentage of your gross income (anywhere from 30-50%) makes the most sense. As your business grows, you may switch to a straight salary method (especially helpful when you elect to be taxed as an S-Corp), and pay yourself a bonus each quarter.
At Hawthorn Law, we follow the Profit First method of accounting (affiliate link), which means that we have 4 separate accounts set up, and a certain percentage of gross income goes into each. Here is a quick outline of those accounts.
Account #1 – Operating/Expense Account
This is the account where all the money comes into. I recommend that you hold back between 30-40% of your gross income to pay expenses. If you can’t afford your expenses on that amount, then you should take a closer look at what your business is spending your money on.
In the early stages, this percentage will be higher. But as your income gets more predictable, this amount will go down. When you start to hire staff, this amount will go up again (but so will your gross income).
Account #2 – Owner’s Pay Account
This is the account you will use to pay yourself a salary. You will typically take between 40-50% of your gross income and deposit it into this account when you make your distributions.
As your business grows and you earn more gross income, you may start to pay yourself more, even without increasing your percentage allocation to this account.
Account #3 – Tax Account
This is where you will deposit the money you will use to pay taxes. I recommend between 5-10%. As you get into a rhythm with this system, you may adjust your tax allocation accordingly.
Every quarter you can use this money to pay your quarterly estimates. You will need to work with an accountant to help you in this area. Don’t ever touch the money in this account – consider it “Uncle Sam’s Money”.
Account #4 – Profit Account
This is the account you will use to deposit the profit from the business. Like the tax account, the money in this account should not be touched. Each quarter, you can withdraw ½ of the balance of this account to pay yourself a nice bonus. Won’t that feel nice?
When Should I Convert to or Elect Treatment as an S-Corp?
Although single member LLC’s are easy, the big drawback is that you have to pay self-employment taxes on your entire net income with an LLC.
With an S-Corp, you will only pay self-employment taxes on your salary, as long as it is reasonable.
Once you are earning between $35,000 and $50,000 per year, it will make sense for you to look into switching to an S-Corp because of the tax savings.
Any Other Questions About How to Pay Yourself in a Single Member LLC?
The bottom line is that you want to have a set system in place to make sure you are paying yourself systematically and regularly. This system should be set out in a well written Operating or Shareholder’s Agreement to help insulate avoid piercing of the corporate veil in the event your business ever gets sued.