How Do Business Owners Get Paid - Part 1
Sole Proprietors and Single-Member LLCs (SMLLCs) with default tax treatment
Sole Proprietor
If you’ve decided to operate a business as yourself without forming a separate legal business entity, you might be thinking … well, the money flows right into my personal account so that’s how I get paid … while that’s certainly true, it’s not the ideal way to operate as a sole proprietor.
It's best to keep your personal and business assets/liabilities separate and distinct while simultaneously keeping good records of all your business transactions (implement/use a good accounting system or solution not a makeshift one). Open a separate business checking account to be used for your sole proprietorship and put all monies from your business into this account and pay all business expenses out of this account. Many banks offer banking solutions for startups and small businesses (including sole proprietors) so do your research and finds banks which offer the most bang for the buck (low minimum monthly fees and options for easily waiving those fees).
That said, when it comes time to pay yourself as a sole proprietor, you’ll take an Owner’s Draw from the business by writing a check to yourself from your business/business checking account. The amount of the draw should depend on business performance and how much you need to keep in the business to sustain operations. Remember to properly record the Owner’s Draw in your accounting system.
Also keep in mind that the Owner’s Draw is not subject to tax withholdings, so you’ll likely need to pay estimated taxes including self-employment and income taxes to the IRS, state, and local tax agencies on a quarterly basis.
Single-Member LLC (SMLLC)
A single-member LLC with default tax treatment is considered a disregarded entity for tax purposes and is treated like a sole proprietor. However, unlike a sole proprietor, a single-member LLC is a distinct legal business entity separate from its owner (gain the benefits of limited liability protection provided you don’t pierce the corporate veil) established at the state level by filing Articles of Organization (also referred to as Articles/Certificate of Formation) with the respective state’s Secretary of State. A single-member LLC may also apply for an EIN with the IRS (typically will need one to open a business bank account) and may have other compliance, reporting and filing requirements (with associated fees/costs) at the state level.
When it comes to paying yourself as an owner of a single-member LLC, you will take an Owner’s or Member’s Draw like that of a sole proprietor. You’ll write a check from the business to yourself for the draw. Remember to record the draw properly into your accounting system.
Again, the Owner’s or Member’s Draw is not subject to tax withholdings, so you’ll need to pay estimated taxes including self-employment and income taxes to the IRS, state, and local tax agencies on a quarterly basis.
This is intended as a general overview so be sure to consult with a CPA or tax professional for questions related to your specific business and tax situation.