One of the most rewarding experiences of being a small business owner is the realization that you get to pay yourself. You have invested the time, hard work, and money to turn your dream of owning a childcare business into a reality, and your efforts come to fruition through the act of providing your own paycheck. How you approach your own compensation as a business owner will have a significant impact on the financial well-being of your business. The following guide offers insight into the different ways you can pay yourself and the best way to approach payday.
Draw Versus Salary
As a small business owner, you will generally choose one of the following options as you pay yourself from your business: draw or salary.
- Draw – As the small business owner, you take money out of the business bank account for your personal use. Some business owners take a draw at regular intervals, while others take a draw at various times as needed.
- Salary – You determine a reasonable wage for yourself as the small business owner and cut a paycheck for yourself at regular pay periods via your payroll.
When deciding whether to pay yourself in the form of an owner’s draw or salary, you will want to consider the advantages and disadvantages to both methods.
Advantages of an Owner’s Draw
- An owner’s draw allows you to dip into the business bank account at will instead of waiting for pay period to roll around. Some business owners like the flexibility this option provides.
Disadvantages of an Owner’s Draw
- Ironically, the flexibility provided by the draw method can also be a disadvantage. When you can take money from the business on a whim, it is very easy to overpay yourself by not having a pre-determined wage.
- Irregular withdrawal of funds reduces your business equity. This means you will have less funds for future business spending.
- Depending on the tax classification of your childcare business, you will need to pay taxes on your owner’s draw in a lump sum. For example, if you are the sole proprietor of your daycare business, the draws you take from your business will be subject to self-employment taxes. If you aren’t careful, you could end up owing the IRS a lot more money than you thought.
Advantages of a Salary
- A salary paid through your payroll provides compensation at regular, stable intervals—weekly, biweekly, or monthly. This makes it much easier to track your own pay as an expense of your business, showing you what the true profit of your childcare business is after you get paid properly.
- Adding yourself to the payroll means a lot less administrative work for you. Your income taxes are withheld from each paycheck automatically, just as they are for the other employees on your payroll. You don’t have to worry as much whether you set aside the right amount of money for self-employment taxes when Tax Day rolls around.
- Including yourself on the business payroll helps you leave a “paper trail” that can be advantageous to both your personal and business financial pursuits. Regular paychecks help you apply for a mortgage and other bank loans.
Disadvantages of a Salary
- An owner’s salary should fall within IRS guidelines of reasonable compensation. You will need to do some research to determine an appropriate wage for yourself as the owner of your childcare business. Sometimes small business owners struggle with figuring out the right salary for themselves.
You can see from our guide to paying yourself via owner’s draw or salary that we generally favor and recommend to small business owners to pay yourself a salary from your business payroll. The advantages to paying yourself from your payroll far outweigh the disadvantages and save you from the mistakes many business owners make when they take an owner’s draw.
It’s important to note that if the business performs better than expected, you aren’t limited to only a salary. You can also take draws on top of your salary if you feel there is excess cash in the business bank account. You should just be aware that you aren’t remitting taxes on that draw like you are through payroll, and should consider saving 15-20% of your draw for the upcoming taxes owed on that income.
If you do choose to opt for an owner’s draw only, we encourage you to set yourself up for success by adhering to a strict draw schedule, at regular intervals and with regular amounts, similar to the wage you would pay yourself through payroll. We also encourage you to set aside 15-20% of your draw in order to cover the Social Security, Medicare and income tax that you owe on the amount you draw. In the end, you want to be sure you can track your income and expenses as easily as possible to keep your business fiscally fit.
Do you need help figuring out the right salary for you as the owner of your childcare business? Do you wish you could leave your payroll processing in the hands of someone you can trust? The experts at Honest Buck Accounting are here to help! Call us today to learn how we can meet the accounting needs of your business and help you grow.