257 - How to Pay Yourself Based on Business Structure
On today's bonus episode of the podcast I'm sharing how to pay yourself based on your business structure. This episode is for you to get verification that you're paying yourself correctly, discover you're doing it incorrectly and learn how to change your system, or learn how to do it in the first place.
Always a bit surprised about this question, but when I think about it, it is confusing and was something myself and my friends chatted about when we started our law firms, because we didn't even know. When I started my business several years ago, I joined an incubator as a solo practice with a group of six of us who passed the Bar exam at the same time and the law school has a faculty member that runs a six week incubator on how to start your legal business.
So today, I'm breaking it down. What's the lingo and how does it work? On the next episode of the podcast I'll be going into greater detail about the different types of business entities so if you feel lost during today's episode, check out Thursday's when it comes out then head back here.
For tax purposes, LLCs and sole props are taxed the same. We know LLCs and sole props are basically the same. These types of business are based purely on profit - you have income, expenses and profit. All the profit is your money because you and your business are the same and that is what you are taxed on. You pay your taxes on this profit whether or not you pay yourself.
So what does that mean? You have income. You have expenses. You have profit. All the profit is your money. You pay taxes on it regardless of whether you pay yourself. Paying yourself isn't a "taxable event." This is why sole props can technically just use personal bank accounts, which we, of course, don't recommend.
Instead, you have a personal account and can simply transfer yourself money from your business bank account whenever you want. That's paying yourself. And we love that. It's good to develop a habit of paying yourself because it forces you to be profitable. Paying yourself in a routine way breaks the habit of paying yourself when you need money for groceries or a car payment and helps you budget better when you have a set, routine income coming in. Inside Profit Rx I encourage beginner business owners to pay themselves every Friday because we do a finance Friday routine where we update our bookkeeping, pay ourselves, follow up on any invoices we're owed or payments we need to make, and check our credit score.
With partnerships and multi-members LLCs, it's similar. You're taxed on all profits, but paying yourself is ESSENTIAL because otherwise, you have taxable income with no actual income to pay that tax. And yes, you should be paying the taxes personally.
Let's say you have a partnership and your business makes $100,000. You have expenses of $40,000. Now let's say you leave that remaining $60,000 in the bank. Assuming you are in a 50-50 partnership, each partner is going to end up reporting $30,000 in profit on your tax return. You get a K1 that reports that. It shows you have $30,000 in profit and $20,000 in expenses. And let's say you have a 20% tax rate, you're going to owe $6,000 in taxes. If your business hasn't paid out any money, you're going to owe $6,000 in taxes but you haven't pulled any money out of the business to pay that tax and you don't want to wait until tax time to pull that money out.
Ideally, you should be paying quarterly estimated taxes throughout the year so you want to pay yourself throughout the year as well. When you are in a partnership, the business should not be paying the taxes. A partnership is a pass-through entity meaning your taxes are based on your personal income, like an LLC or sole prop.
The example I like to give is if Partner A is single with no other income, their entire income is the $30,000. Let's say Partner B also has a full-time job making $50,000 plus a spouse making $100,000 plus the $30,000 is $180,000 so that's going to put them at a different tax bracket than Partner A which is why the business does not pay the taxes. So it's really important you pay yourself in your partnership.
Once you have an S Corp, you are going to pay yourself in two ways. You have to put yourself on a reasonable minimum salary under the law and ideally you want that to be on a routine basis, though legally it can be a lump sum payment. I like to run salary twice a month. I process it in my business on the 15th and the last day of the month and that's when I do it for my employees too. Once you pay yourself, anything left over is your profit and you can transfer additional profit to yourself and we treat that as a profit distribution. Salaries are subject to both income tax and self-employment taxes and your profit distributions is only subject to income tax which is how S Corps save us money. Ideally, you want to pay yourself these distributions on a monthly or quarterly basis though the vast majority of people, including myself, are not doing it in this ideal way. Not ideal, but I pay my personal credit card from my business bank account as the profit distribution. In the New Year, I'm going to be increasing my salary and I won't need to do this anymore.
Want more information? Check out Episode 56 of my podcast, Paying Yourself in a Single Member LLC.
If you have any questions, post them in my Facebook group, Braden's Besties. I'd love to chat about them.
