Entrepreneurs: Don't Forget to Pay Yourself (but Not 100%)
Post #51: Reduce your tax bill with a simple payroll calculation.
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Did you know…?
[A study revealed that] 93% …of business owners were overpaying on their taxes – regardless of whether they were paying for a high-priced accountant or not. (source)
In this newsletter, I’ll cover the challenges of calculating how much to pay yourself as an entrepreneur and why just taking all of the net profits is a bad idea.
Specifically:
4 reasons why most business owners struggle to pay themselves
Taking 100% of your net profits as payment will lead to tax over-payment
Setting a reasonable salary and taking more of your income via profit distributions
Understanding the tax implications of paying yourself
One of the biggest shifts from being an employee to being a business owner is figuring out how and when to pay yourself.
Unlike a traditional job where you receive a set paycheck, business owners must navigate tax implications, profit reinvestment, and financial sustainability.
Getting it right can mean the difference between long-term business success and an unexpected tax burden.
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Most Business Owners Struggle to Pay Themselves
Many entrepreneurs struggle with paying themselves properly. But, without a structured approach, they risk financial instability, unexpected tax bills, and even potential IRS scrutiny.
See if any of these challenges sound familiar to you:
Uncertainty About Pay Structure
New business owners often don’t know whether to take a salary, draw profits, or both. The lack of clarity can lead to inconsistent payments or financial strain on the business.
Inconsistent Income Streams
Many entrepreneurs don’t pay themselves on a regular schedule, instead taking money from the business when they need it. This can make budgeting and tax planning difficult.
Avoiding Payroll Due to Complexity
Setting up payroll may seem like an unnecessary hassle, especially for single-member businesses. However, a proper payroll system can reduce tax liabilities and ensure compliance with IRS regulations.
Fear of Overpaying Taxes
Without a strategic compensation plan, business owners may overpay in self-employment taxes or fail to take advantage of tax-efficient salary structures.
💡 Tip: Did you know that you can sock away up to $81,250 per year with a 401(k) plan setup through your own small business, if you are over 50 years old? Even business owners under 50 can save up to $70,000 per year! (Source)
That is not small potatoes and can make a serious dent in your taxable income!
By understanding these challenges, business owners can take proactive steps to implement a structured and tax-efficient way to pay themselves.
❌ The Wrong Way
Keep in mind that everyone’s circumstances are different, so when I say that this is the “wrong way”, I make some basic assumptions about the average business owner.
Taking 100% of Profits as Your Salary
Many new business owners make the mistake of taking every dollar of profit as personal income.
While this may seem logical — after all, it’s your business — this approach can create significant tax liabilities.
Business profits are subject to various tax structures, and treating everything as salary means you’ll be paying self-employment taxes on the entire amount.
Instead, a more strategic approach is needed, if you don’t want to be part of that statistic I shared earlier (i.e.: 93% of business owners overpay their taxes).
✔️ The Right Way
Again, your circumstances may vary, but this is a better way to pay yourself as a small business owner with a relatively straightforward setup.
Set a Reasonable Salary & Use Profit Distributions
The best way to pay yourself is to establish a structured approach that minimizes tax exposure while keeping the business financially stable.
(1) Determine a Reasonable Salary
If your business is structured as an LLC taxed as an S-Corp or an actual S-Corp, you must pay yourself a "reasonable salary" before taking distributions.
The IRS requires this to prevent business owners from avoiding payroll taxes entirely. A reasonable salary is what someone in your role would earn if hired by another company.
Learn more about LLCs and S-Corps:
(2) Use Profit Distributions (Dividends) for Additional Income
Once you’ve paid yourself a base salary, any remaining profits can be distributed as dividends or pass-through income.
This allows you to avoid self-employment taxes on the entire amount, lowering your overall tax burden.
However, these distributions should be calculated carefully to ensure the business retains enough working capital for growth and stability.
Learn more about how to manage your business finances:
(3) Plan for Taxes in Advance
Unlike traditional employees, business owners must account for self-employment taxes, estimated quarterly tax payments, and potential state taxes.
Failing to plan ahead can result in an unexpected tax bill at year-end.
Watch out for Tax Scams!
(4) Reinvest in the Business Strategically
Not all profits should go directly into your pocket.
Smart business owners reinvest some earnings into growth — whether through marketing, hiring, or product development.
A structured approach to reinvestment can position your business for long-term success.
Learn more about creating a business plan:
If you are looking for help with this topic, and you’re not sure where to start,
feel free to reach out to me directly.
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Understanding the Tax Implications of Paying Yourself
How you pay yourself directly impacts your tax burden. Business owners who don’t plan properly often end up overpaying taxes or facing unexpected liabilities.
Here’s what you need to know:
Self-Employment Taxes
If you operate as a sole proprietor or single-member LLC, all profits are subject to self-employment taxes, which cover Social Security and Medicare.
This rate is currently 15.3% on net earnings.
Payroll Taxes
If you pay yourself a salary as an S-Corp owner, both you and your business will share payroll taxes.
However, your distributions are not subject to these taxes, reducing your overall liability.
Quarterly Estimated Payments
Unlike employees who have taxes withheld from paychecks, business owners must make estimated tax payments throughout the year.
Missing these deadlines can result in penalties.
Deductions and Business Expenses
Properly structuring your compensation allows you to leverage deductions that reduce taxable income, such as health insurance, retirement contributions, and business expenses.
The Best Salary Isn’t a Guess—It’s a Calculation
There’s no one-size-fits-all number when it comes to your salary.
Factors like industry standards, business revenue, and tax efficiency all play a role in determining what makes sense.
The key is to balance personal income with business sustainability while keeping tax efficiency in mind.
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