How to Pay Yourself the Right Way: 4 Tips to Withdraw Cash from Your Business
You’ve started your business and you have some money, and now it is time to take it out and pay yourself. There are some right ways to do it and some wrong ways to do it. This blog will talk about 4 ways to help make sure you do it the right way.
Getting Paid
No matter how much passion you have for helping others, at some point, you need to get paid for your services. Some people have a tough time pricing themselves appropriately. They undervalue themselves, especially early on in the business. But nevertheless, eventually, you will start to make money and be able to take some home and pay yourself.
We actually help a lot of people with that at Origins Incubator. Our mentorship program is fairly comprehensive. We cover a lot of the mindset stuff too, and not only do we help people create their offering for patients what they are going to deliver, but we also help them write that out, so that they feel confident in saying the price out loud because they know that what they are giving is high in value. It also allows them to have a work/life balance and make sure that they can help keep their doors open because if you are underpriced, you may go out of business. As we like to say, you should put on your own oxygen mask before helping others.
So, just because you make some money in your business, it doesn’t mean you can’t give away some scholarships or do some volunteering. Perhaps, you want to give some medical services away for free, underprivileged groups a discount, or a big group a lower fee. You can do all of that.
Besides helping others, the fun part in running a business is when you get money and you need to pay yourself or want to pay yourself. However, for tax purposes, you may want to consult with a CPA. I recommend CPAs because they pay for themselves in tax savings and lack of mistakes that you would make yourself.
I’m not a tax professional. These are some tips that I picked up on the way, those that I follow myself.
Here are 4 tips to withdraw cash from your business to pay yourself.
Profit Is Profit No Matter Where It Is
LLC is pass-through taxation, same as sole proprietorship and same as partnership. They are pass-through tax entities you pay tax on profits whether you withdraw it or not.
Let’s say you’ve made a profit, and $100,000 is in your business banking account. Even if you never take that money out and put it in your own personal checking account, you are still listed as having that profit for your business tax return and for your personal tax return as well. So, whether or not it is sitting in your business bank account or you’ve moved it to your personal bank account, it’s still profit. That’s something to keep in mind.
Separate Bank Accounts
The first thing to do is you should have separate bank accounts for your business and your personal fund. Whatever kind of entity you are setting up, LLC, PC, or any other kind, you need to set up a separate Employer Identification Number (EIN). You want to get an EIN with the Internal Revenue Service (IRS). It’s free to get. It’s effectively a Social Security Number for your business, the Tax-Id number. Even though you may not have any employees yet, it’s still called an EIN.
The #1 reason why you want to have separate bank accounts is that it helps create you with a limited liability of the company. In other words, just because you have a company, that doesn’t mean that your personal assets are 100% guaranteed to be protected. There are limited liability companies, but they are not zero liability companies. Right? The business is still liable for those debts, but the biggest thing that would allow a court to “pierce the corporate veil” is commingling of funds. Let me break that sentence down for you. When a business has that or when there’s a judgment against the business, only the assets of the business can usually be attached to pay off that debt. Right? So, the business only had $100,000, and there’s a judgment of $200,000. The business has the choice to either go bankrupt and come up with a payment plan or go out of business entirely, but one of the options is not grab the assets of the owner (cars, vacation homes, personal bank account, 401K) and then pay off the debt with that. That’s the limited liability of a corporation as well as a limited liability company. That’s not bulletproof. And one of the most common ways that court can reach through and pierce the corporate veil is commingling funds or mixing personal funds and business funds, usually in the same account.
Pay Debts from the Correct Account
Another way that the corporate veil is pierced is if you pay for a lot of personal things out of your business account and/or pay for a lot of business things out of your personal account, and you don’t keep good records for reimbursement. The easiest way to avoid all of that is to have a separate bank account. It’s best if each separate bank account is at a separate bank, a separate bank for your business and one for your personal funds, but it doesn’t need to be. That also makes it a lot easier to keep track of your books, which you may be doing throughout the year as well, so when tax time comes, it’s a lot easier to track your business expenditures vs. your personal expenditures.
Create a Paper Trail
Track owner withdrawals by check or Electronic Funds Transfer (EFT), also called Automated Clearing House (ACH) transfer. That helps create a paper trail so owner withdrawals are not the same as salary. Check with your CPA at a certain point. If you’re running the business and you are working in the business, you have to take a reasonable salary. What that reasonable amount is is up to you and your CPA, but owner withdrawals are not the same as salary. Salary usually goes through a payroll company. You can use QuickBooks, which has a payroll add on feature, but there are many third party companies as well that will help you with payroll, or your CPA may have a payroll service. Those payments go through payroll, and you deduct some payroll taxes out of it as the business and the employee deducts some payroll taxes out of that as well. They pay half of those.
But tracking your owner withdrawals, owner pay, is different. Say I own stock in Apple, but I don’t work at Apple. So, I don’t draw a salary from Apple, but I get some dividends every once in awhile, not a lot, but a few cents every quarter in dividends. Right? I don’t pay employment taxes on those dividends, and so similarly, the tax structure between salary and owner withdrawals are different. So that’s something to check with your CPA for as far as salary determinations, what is a reasonable amount for you, and also being able to track those ownership distributions either by check or by EFT.
Set Aside Money for Taxes
Last, now that you have a business, you (if you are not taking 100% of your income through salary and some of it is coming through ownership distributions) set aside some money for taxes. Preferably, you put them in a different bank account. It could be the same business bank, but you just have two checking accounts and a savings account and one of those checking accounts is a tax-holding account. How much? Generally, people recommend 10-15% of gross revenue be set a side in a tax account. If you set aside too much throughout the course of the year, you just gave yourself a tax refund, but the IRS didn’t hold onto the money. You may at a certain point in your business start to have to pay other quarterly taxes, so this account can work for that too. It can also just be a holding account for March 15th when business taxes and returns are due. It can just be your holding account, and you can make a payment at that point, or reassess how much you are withholding for next year. So, if you are withholding 15% this year and you kept most of that, you didn’t have to give money to Uncle Sam or as much as you thought. Then you can maybe adjust that down to 12% or 10% next year.
We actually use at our businesses a system called Profit First based on the book of the same name by Mike Michalowicz. And we actually have about 5 bank accounts at each business. It all sounds very complicated, but everyone who has ever adopted this system that I’ve spoken to says that it’s changed their life. So, I recommend this book and at least skimming it because it can be helpful to know where all your money is.
Conclusion
In a nutshell, when money comes in, you allocate it into different buckets, and each bucket ends up being different bank accounts at your business. So, you put some money in operating costs and some in ownership pay which is profit, a salary for you. You put some in taxes and some in a slush fund. This system has changed many people’s lives and made it more peaceful to handle the finances in their business. So, I’ll put a link to that as well.
There you have it: 4 tips on how to pay yourself directly as an owner.
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