Today let’s address a question I see quite often: How do I pay myself? As a shop owner who also happens to be an accountant, sometimes I lose touch of the questions my non-accountant friends have about running a biz. This one happens to be one of them, and it’s high time we discuss it!
I am breaking this discussion up into two parts – first, we’ll discuss the logistical accounting components of paying yourself. Next, we’ll discuss the actual practice & mindset of paying yourself, an options regarding how often or how much to pay yourself.
I do recommend that you practice good financial skills and have your business funds separated from your personal funds (read more about getting a biz bank account here). That means that your sales don’t just automatically flow to your personal bank account, which means that at some point, you have to literally pay yourself from your business.
How exactly are you supposed to do that? Is there a right way or a wrong way? What are the rules?
Your business entity matters.
First, let’s start by discussing how to pay yourself as a sole proprietor. If you start running a business and there’s just one of you, you automatically default to being considered a sole prop. That’s your business entity. If there are two or more of you, you’d automatically default to being considered a partnership.
We sometimes get confused and think we have to “do something official” to become a sole prop. But really, just running your business (with the intent to make a profit, as discussed here) makes you a sole prop – even if you haven’t registered for a tax permit or gotten your DBA or filled out any sort of paperwork.
There aren’t really any rules when it comes to paying yourself as a sole prop.
So assuming you are indeed a sole prop, there is not really anything required when it comes to paying yourself. You don’t even really HAVE TO pay yourself. You may choose to just re-invest all of your profits back into your biz (though I don’t recommend that!).
As a sole prop (without an LLC!), you can pay yourself in any of the following ways:
- Wireless transfer from your biz bank account to your personal checking account
- Write yourself a check
- Withdraw cash from the ATM
- Pay some personal bills from your biz account
- Transfer money out of your business PayPal account
- Pocket extra cash from your craft show or local event
Some of these methods are better than others simply because they are more “legit” and the paper trail is cleaner. But if you’re a sole prop, technically there is nothing wrong with any of the above methods of getting paid.
How to record paying yourself in your books
Paying yourself from your biz is NOT considered an expense, for bookkeeping or for tax purposes. As a sole prop, you are taxed on your business net income (sales minus expenses) regardless of how much or how little you actually paid yourself from that net income.
You do not deduct the amounts you pay yourself from your business sales in your books. It’s basically like a draw or a transfer, not an expense or a cost. If you’re using a double-entry bookkeeping system like Quickbooks, you’d reduce (credit) your cash by the amount you paid and debit an equity account like owner’s withdrawal.
If you’re using a Paper + Spark spreadsheet, you wouldn’t record the amount you paid yourself as an expense anywhere on your spreadsheet. I usually keep track of the amounts I pay myself by entering it under the bottom line of my net income. That way I can still keep tabs on it, but it’s not affecting my bookkeeping numbers.
The amount you pay yourself goes absolutely no where on your Schedule C. Again, you’re taxed on your business net income or loss, regardless of how much or how little ended up in your own pocket.
What about LLCs?
If you’re a single member LLC, you are usually taxed just like a sole prop (unless you make a special tax election to be considered an S-Corporation for tax purposes). So the same general rules about being a sole prop and paying yourself still apply.
However, you need to be a little more formal with paying yourself in order to keep your limited liability status in tact.
With LLCs, there’s this whole concept of not “piercing the veil” of limited liability (does anyone else just hate the whole weird “piercing the veil” phrase? or is it just me?). If you “pierce the veil”, you may lose your limited liability protection. That means you put your personal assets at risk if your business is sued, which is likely the entire reason you GOT your LLC to being with, right?
One of the ways you can accidentally pierce your veil is by commingling your assets, like not having a separate business bank account or paying a personal bill directly from your business bank account. To avoid trouble, if you are an LLC, you will want to formalize your payment process a bit. Make sure to not pay personal bills directly from your biz account and vice versa. Always deposit biz money to your biz account, not your personal. Basically, keep your personal stuff personal, and your business stuff business.
Tune in next week.
That’s it for the logistical cut & dry components of paying yourself – what the rules are (or aren’t!), what to do for your books, and how it affects your taxes (it doesn’t!).
Tune in next week for my second post about paying yourself. I’ll discuss a few options for figuring out how much and how often you want to pay yourself as a handmade seller.
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