How to Pay Yourself as a Business Owner [Video]

Understanding how to pay yourself as a business owner can be tricky. Should you reinvest or take home the excess money? In this video, we breakdown what you need to know about salaries, owner distributions, benefits, and deductions, based on your legal structure! Read the full transcript below.

Bring Money Home or Reinvest?

Michelle Smalenberger, CFP® (00:00)
So now that your business is kind of growing, you have some income coming in. You might be wondering how to pay yourself as a business owner. How should you balance growing your salary or what you’re taking home versus reinvesting in your business? This is, like you said, this can be a hard one because to make our business better, grow faster, grow differently, we could maybe need more money. But at the same time, we want to be taking money home to start maybe being able to live a little bit more than the rice and beans we were putting ourselves on in the beginning, how do you kind of think about that change over time or even starting?

Trevore (00:33)
Yeah, I tend to think of it as don’t bring money home unless you have to. But one of the things to keep in mind is, if you’re able to keep funds in the business, you’re able to allow those funds to grow and multiply much more than you would of being able to go out to restaurants more frequently or maybe go on a vacation or something like that.

But you do have to find that happy medium to say, where is that point going to be for us in terms of, hey, I can reinvest this versus I really want to bring this home or my family really is looking forward to this something because we’ve been working so hard for so long, get it. So let’s make sure we’re reinvesting in your family.

It’s gonna be a different decision for everyone, but as a general rule of thumb, if you can keep the funds within the business and allow those to reinvest and build back into even greater and better things for your business, you’re gonna be better off.

Michelle Smalenberger, CFP® (01:25)
Yeah, and that’s talking about a business that is growing in value too. You can be growing the income, but at the same time, so as a business owner, you’re trying, I think one of the main goals is you want to be able to earn what you should be able to earn doing the job that you’re doing, whether you’re doing it for yourself or whether you’re doing it for someone else. So kind of what is this market salary?

As you grow, you start to be able to maybe put things in place where you can make those decisions a little bit easier. But I think in the beginning, it can be hard. So you really want to weigh how, you know, how is this going to benefit me versus if I take this home? Do we need it? When we talk about getting paid a salary, that’s just like if you’re working in someone else’s business, you’re getting a paycheck. So you’ve got these payroll taxes, you know, being deducted from that.

You want to be deducting, you know, your federal, state income tax, all of that; versus if there’s excess and you say, maybe I’m getting my salary, but there’s still some extra in the business, there’s still some profit, do I wanna take this out? Now it’s, okay, well, do I just take that out of the business and I don’t pay tax on it? You pay tax differently, but you don’t have those payroll taxes on the funds. And so now, this is where as a business owner, how much am I taking out? How am I taking it out?

Salary vs Distributions

So one of the pieces, as we kind of talk about, I just want to touch a little bit more on this kind of salary versus distributions. I guess one of this is it’s a tough balance. And this is where you pay taxes differently depending on how you take money out of the business.

If you’re kind of taking maybe more in distributions, but still a good amount in a paycheck, one thing to keep in mind is that paycheck that you are withholding payroll taxes on, which includes Social Security taxes, is later in life, your Social Security benefit is based on the wages that you did withhold Social Security taxes for. So it is important to just, this is kind of when we’re looking for clients, the now versus the later. As a business owner, it’s easy to forget because you’re like,

I need to take home what I can today. But also just remember, you don’t want to decrease that paycheck too much, to the detriment potentially of a social security benefit later because social security does cover a decent amount of expenses. It’s not meant to cover everything, but just balancing those, those are kind of the things you need to keep in mind. So whether you’re talking with your accountant or if you have a bookkeeper, things like that are good conversations just to be mindful of when you’re balancing how much income and how you take that out of the business.

Importance of Your Legal Structure

Trevore (04:11)
Yeah, and kind of what you’re talking about there is one of the big financial planning things that we help clients that have businesses kind of run through, right, is the whole idea of salary versus distribution. And this mostly comes into play for business owners that are S-Corps, right?

Sole Proprietorships and LLCs

Because if you’re a sole proprietor or you’re an LLC and taxed as an LLC, because LLCs can also be taxed as escorts. But either way, if you’re a sole proprietor or an LLC, all of the income that the business comes in, that the business brings in, is essentially gonna flow through to you, and unfortunately, you’re gonna owe self-employment taxes on that. And that’s basically both sides of the FICA taxes, 7.65, so it’s a total of 15 plus percent. And that’s not great to have to pay that tax.

Corporations

Whereas I think what you’re alluding to there is when you are an S-Corp, you have the ability to say, well, my salary is this. And even if my business still brings in after my salary, additional money, well, that could be considered a distribution instead of salary. But the one big key component is there is always reasonable comp because the IRS knows to say well just because someone’s an S-corp, You know if you’re running a business and you’re only paying yourself $10,000 a year to run that business The IRS is pretty wise to say hey hang on that doesn’t pass the reasonable Comp test or the sniff test if you will.

But the other thing you’re also looking to is let’s say you set your salary. Let’s say you’re an S-Corp. You have $100,000 of income that’s coming in, but you only set your salary at $10,000 and 90 % of that or 90,000 is distribution not subject to the Social Security and Medicare tax or whatnot.

Well, you’re also hurting yourself for the future is in retirement years. Well, now you’re working off of an earned income figure of $10,000 instead of potentially a hundred, right? So there are multiple factors at play that you want to make sure that if I pull this lever a certain way, what’s going to be the impact downstream of three other things. And it’s really important to have conversations with trusted individuals around you to work through that.

How to Find Employee Benefits

Michelle Smalenberger, CFP® (06:26)
So once we kind of get past this point and we’ve got salary, income coming in. Now we start to think, okay, our businesses may be maturing a little bit. And so now we start to think about, well, what are other things that my business could be covering for me besides a salary? Are there other things it could be paying for? And is this financially beneficial for my business to start paying for some of these things?

Retirement Plans

Trevore (06:47)
Yeah, so the big ones that come to mind are retirement plans, what that looks like. So if you are a single person, or maybe it’s just you and your spouse that work in the business, one of the things you can look at using is a solo or an individual 401k. And the costs on setting those accounts are really, really low. The administration is really, really low. We’ve helped a number of clients set those up. But they offer kind of the largest available beyond defined benefit plan. They offer the largest annual contribution limit to be able to get funds into those accounts

You basically can save $23,000 a year in 2024. If you’re over age 50, there’s a catch up for 7,500. The rules are gonna change pretty substantially for 2025, but only to the benefit. But you can sock away a lot of money on a pre-tax basis using that account. So retirement is a big one, but there are other options beyond a solo 401k as well. If you have owners, you can still do a 401k. But now you’re introducing administrative costs for hiring the record keeper, the third party administrator and stuff like that. Retirement plans can still be a wonderful advantage.

Health Insurance

The next big one would probably be health insurance. That’s something that, we are really well trained to get our health insurance from our employers. And I know that there’s been some change and some movement away from that here in the past 10 years or so. But the recognition is most people do get their health insurance either from their employer or if they’re retired from Medicaid.

So now if you’re going to look at a health insurance plan with your business. Now you’re going to have to work with a broker to see, okay, what is this plan going to look like? There are some state available options that you can work through. There are different rules depending on what state you’re in, but most of them are pretty well documented. But let’s just say you’re going to work with a broker and they’re going to help you pick this insurance plan over that insurance plan or whatnot.

One of the first things that’s hard to think about or be mindful. Lots of these group plans, you have to meet a certain minimum number of people before you can even enroll. And three has been a number that’s been touted around just to get the plan started. It doesn’t always have to stay at three. But if it’s just you and the business, it could be really hard to get a group health insurance plan through one of the big names if you don’t have more people covered. So the other alternative is to say, can you go back to the marketplace? But that’s not necessarily going through the business.

Disability Insurance

Following health insurance, then we’re just going to keep working down the list of disability insurance. That’s something that I really encourage clients to take a look at doing, especially if you are a solo business owner, because now you’re getting to the point where if you’re looking at employee benefits and having your business cover them.

Generally speaking, your income is well enough to the point where you’re not scraping by. So your income is growing through the business. It’s starting to become profitable.

But if you’re still a solo shop, now you’re in a situation where if something happens to you, how are you gonna continue bringing funds into your house in the event of an accident, right? And this is an accident where you might be paralyzed or you can’t work for a little bit. Disability insurance is paramount and super, super important and I think often overlooked as an employee benefit to look at.

How to Use Profits and Deductions

Michelle Smalenberger, CFP® (10:35)
Yeah. And so even further, what happens as a business owners, you just have to keep thinking about this. What do I do with this excess? What do I do with this now? And over time, you’re adding things that you always want to have in place.

And not every expense is deductible or is fully deductible. So it’s not that if I spend a dollar, that decreases the profit in my business. That’s where it’s very important to know which expenses are deductible, which expenses aren’t deductible. You’ve got to understand, if I spend a dollar here, that’s going to help with my taxes here.

Trevore (11:11)
Just to make sure it’s super, super clear, this is just a hard concept to grasp. Right. So just to put it really simple and clear, if I have a $50 lunch that I’m going to take some friends out to or something like that, first and foremost, it has to be a business purpose, right? You can’t just be hanging around and carrying on with your friends and stuff like that. It has to be related to your business.

So if you have $100 of income. Now because of that lunch, you potentially at most could have $50 of income, 100 minus the 50. But oftentimes with meals, one of the things that’s often overlooked. They are deducted differently than a lot of other expenses. You know, if you paid for office supplies for 50 bucks, that’s generally 100 % deduction. But meals are a 50 % deduction. So you’re not even getting the $50 as a deduction, you’re only getting 25.

How to Pay Yourself as a Business Owner

Michelle Smalenberger, CFP® (12:13)
Well, that’s why I think it’s important just to touch on. I think there is just kind of this misconception of like, business owners, you can just write it all off.

Listen to our full conversation in episode 54, “So, You Want to Start a Business.” Find it by streaming the Behind the Designs podcast.

If you have more questions, then reach out! We specialize in complexities like executive compensation, tax planning, and investment management. Our team would love to see how we can help bring confidence to you and your family’s finances.

Thanks for watching!