“How do I decide how much to pay myself?” When I saw this question on April’s AMA list, I knew it had to be this week’s newsletter. Compensation is personal, technical, and legal, all at the same time. It’s really three questions: what you want to pay yourself, what you can afford to pay yourself, and what happens when you put the money into your personal bank account. 

What do I want? Philosophically, I have no opinion on how big this number should be. That’s up to you. As a reader of this newsletter, I assume you’re a socially-minded person, without designs on world domination or hoarding personal wealth equivalent to the GDP of Qatar. Frankly, you’re more likely to be picking too small a number, which creates problems with your pricing and margins. 

I trust you to pick a number that makes you feel rewarded and takes care of you and your family. 

Next, what can you afford?

One approach is called Profit First. Profit First can help you find the maximum you can pay yourself without compromising operations. This is a cash management system that considers your total revenues, minus owners compensation, minus taxes, to set a budget for your business operations. The system includes suggested proportions to guide your budget. If you’re interested in exploring Profit First, check out this post from our friends at accounting firm Countless, which includes suggested allocations at various revenue levels.

Another consideration is total compensation. When you leave a W-2 job, your goal might be matching your employee wage. However, as a business owner, you have other ways you can compensate yourself, which can also lower your tax bill. Qualified business expenses like internet, mobile phone, travel, car costs, home office allowance, and more can be paid by your business on a pre-tax basis. That might lighten the amount you need to pay yourself to cover personal bills. Additionally, you might want to fund upgraded health or disability insurance or a tax-deferred retirement plan to the tune of $69,000 in 2024. (2X if you include your spouse.) Maybe you want to hire your kids. All of these are compensation types beyond wages. 

If you aren’t yet able to pay yourself your ideal number, pick a place to start and keep that bigger number as a goal. If you exceed your profitability target for the year, you can give yourself a supplemental payment later. 

Now we get to the rules for paying yourself. 

How often do you need to pay yourself? If you don’t have employees, it’s on your schedule. I recommend once a month to keep yourself honest, also because banks and landlords, but semi-weekly, bi-weeekly, or once a quarter are also good. Technically, even once a year is okay, it’s just not realistic for most of us. 

If you do have employees, you’ll have a regular payroll schedule dictated by your city or state. If you receive W-2 wages, you’ll be paid on the regular schedule. If you are taking owners draws, your pay schedule does not have to match the W-2 payroll.

Finally, how do you actually pay yourself? It depends on how your company is legally organized.

If you’re a sole proprietor, partnership, or single or multi-member LLC taxed as one of these, you will use owners draws. This is quite literally moving money from your business bank account to your personal bank account. Keep in mind that these draws are subject to federal self-employment taxes of 15.3% and federal and state income taxes. Since the government is not receiving deductions from your draws, you may need to pay estimated taxes up to four times during the year. 

If you’re an S-corp or an LLC that’s elected S-corp status, you have two ways to pay yourself. One, you must formally hire yourself as a W-2 employee and pay yourself a “reasonable” wage. “Reasonable” is not firmly defined, but you can use public information to determine what it would cost to hire someone to do your job. You will need to withhold your half of payroll taxes and the company will pay the other half. (A payroll service can make this easier. For small businesses, I like Gusto and Rippling. Solopreneurs with S-corps give The Collective high marks.) 

In addition to your required W-2 wages, you can take distributions of profits. In practice, this is similar to a draw; you will transfer money from your business to your personal bank account. Distributions are exempt from payroll taxes. Between your two pay types, many accountants apply a 40/60 rule: 40% W-2 wage, 60% distribution. Talk to your accountant about your specific situation to steer clear of an audit. If you’re new to S-corps, check out my tips for staying compliant. 

Did you miss April’s AMA? Check out the replay. We talked about hiring your first employee, managing contractor time off, and making my big move to Beehiiv.

Send your questions at any time. And join us on May 9!  Click below to add my 2024 AMAs to your calendar:

Reach 19 million business owners. I love the business podcast How I Built this with Guy Raz. (Check out “AI is smarter than you think” with the founder of DeepMind.) HIBT has invited business owners to reach their 19 million monthly listeners by asking for help. To be considered, make a 1-minute voice memo about your business, the issues or questions you’d like them to address, and how to reach you. Drop that at [email protected] or call 1-800-433-1298. If you’re chosen, a past guest will answer your question, and your company will be featured on the pod. Looking forward to hearing your voices! 

A head start on SB 553 compliance. California employers, a new law taking effect on July 1, 2024, requires you to develop and implement a written violence prevention plan. If you have even one W-2 employee in California, this law applies to you. Noncompliance fines start at $25,000. For a jumpstart, join CDF Law’s free webinar on April 30 to get all the details straight from my California employment lawyers. For your written plan, compliance training firm EasyLlama has a free downloadable template and a paid compliant team training module.

Never enough reminders: own your bank account. Remember when I wrote about MLB player Shohei Ohtani’s bonkers $700 million deferred contract with the Los Angeles Dodgers? He was back in the news last week after his interpreter bestie was found to have embezzled $16.5 million over three years to cover his gambling debts. The interpreter refused to share the bank account information with Ohtani’s professional team and changed notifications so he wouldn’t be alerted to large transfers. 

I will never stop reminding you: do not give up control of the bank account. Check your statements every month. Set up controls like bill pay and administrative account permissions. If you work with a manager, ask for a periodic joint review of your cash flow history. (You know they’re verifying their 5%.) Look askance at anyone who accepts your bank account password. Work with people that require arms-length systems and controls.