Every business owner needs to take home a paycheck, but figuring out how to do that as a freelancer can be confusing. While you could just start taking money out of your business, some owners feel uncomfortable doing so because they’re unfamiliar with self-employment taxes.
As a positive, an owner’s draw is similar to depositing money into your bank account, except you’re taking your bi-weekly paycheck from your own pocket, and you aren’t taxed right away.
What is an Owner’s Draw?
An owner’s draw is when a freelancer, independent contractor, sole proprietor, or single-member LLC business owner takes money from the company for personal use. One major positive of paying yourself with an owner’s draw is its flexibility. You can adjust your compensation at will.
To show proof of income, freelancers can create fake checkstubs. If you’re used to being an employee, a checkstub can offer a sense of normalcy as well as physical proof you were paid.
If you’re a freelancer who runs their own business (LLC, sole proprietor, etc.), the owner’s draw can make it difficult to file your taxes. Ideally, you’ll have two separate accounts: one for personal and one for business. This will make it easier for you to make quarterly tax estimates.
How Much Can I Pay Myself With an Owner’s Draw?
The amount you can pay yourself depends on the type of business you run:
- Sole Proprietor: A single-member LLC, sole proprietor, or freelancer can withdraw as much as they want because they don’t have to listen to other shareholders. Draws aren’t considered personal income, but the tax is allocated to the business owner. The draw itself doesn’t affect your taxes; the money itself is taxed as self-employment income.
- Limited Liability Company (LLC) or Partnerships: Although it sounds odd, you can have two freelancers who operate in a multi-person LLC. If that’s the case, you’ll share business profits with another person. In a partnership or LLC, business owners who pay themselves an owner’s draw split the profits evenly and are taxed as a business entity.
- S Corp and C Corp: Freelancers can turn their single or multi-person LLC into an S or C Corp, but there’s no reason to do so. Not only is it expensive, but you can’t issue an owner’s draw. S Corps and C Corps are paid via the salary method. However, S Corp owners can take non-taxable distributions, but all C Corp distributions are taxed.
For tax purposes, it’s better to stay as a sole proprietor unless you want to convert into a multi-person LLC. Since sole proprietors can exchange business funds back and forth between accounts, there’s no disadvantage to overdrawing as long as your business is profitable.
Still, it’s better to keep some money held up in your business, even if there’s no tax benefit. It’s good business sense to set aside some funds for investments or to accelerate your growth.
How Often Should You Pay Yourself?
There isn’t a hard and fast rule for how often you should pay yourself. However, you should try to keep your payment schedule consistent, whether it’s once a month or 2 times a week. By keeping a consistent pay schedule, you’ll be able to budget and manage your accounts better.
Since you’re self-employed, your taxes aren’t deducted from what you earn. Make sure you don’t overspend and neglect to save for taxes. At the same time, you also have to put some money away for your 401(k). Contributing to your 401(k) reduces your overall tax burden.
As a rule, save 20-30% of your income. Keep in mind that you’ll be able to deduct some of your business expenses, so you’ll likely won’t have to give the IRS the full 20-30%.
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