In today's episode we are going to talk about how to pay yourself when you are running a business.
Now, I'm going to be speaking specifically about dropshipping businesses because that is what we run, but this can apply also to any business in my opinion.
Ways to Pay Yourself:
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What's up everybody. Anton Kraly here from ecommercelifestyle.com, and welcome back to the podcast. In today's episode we are going to talk about how to pay yourself when you are running a business. Now, I'm going to be speaking specifically about dropshipping businesses because that is what we run, but this applies really to any business in my opinion. With that being said, speak to an accountant if you want true advice that has somebody that can sign off on it because I am not an accountant or a lawyer, I don't pretend to be. But this is what I do and this is what I recommend, again, for pretty much everybody out there, especially if you are building an eCommerce store and you're curious like, "Do I just take money whenever I want money? Is all the money in the world just mine? How does this work?" So let me draw this out here for everybody watching the video and everybody listening to the podcast just to walk you through it. But let's just say for keeping numbers easy, your first year in business, you do $1 million in sales. Okay?
I didn't get there until my third year in business, but let's just say you have some amazing breakthrough year and you do $1 million in revenue. Now, let's say out of that million dollars, you have 250,000 that is net profit. So between cost of goods, sold between shipping, between ads, between your merchant fee, between whatever else, your virtual assistant, everything you're paying, you have $250,000 in true net profit that comes in throughout the year. So how do you pay yourself? How do you take money out of the business and put it into your pocket? Well, there's pretty much a million different ways to do it. But the way that I recommend you do it is to first of all, form your business as a separate legal entity, and either form it as an S corporation or form an LLC and choose to have it taxed as an S corporation. Because the way that that works is you can pay yourself a salary, and then the extra money that's still in the business will be paid to you as a distribution. And taxes work differently from salary and distribution.
So again, get an S corporation, pay yourself a salary. The rest of the money you can take as a distribution. But let's look at what that actually means. So when it comes to salary, how much should you pay yourself? My advice, especially in the beginning is keep it modest, but keep it realistic and have it enough to cover your expenses and try to keep it at that. So let's just say you are currently renting a home, and you have a car lease, and maybe you even have a family, and between all of your expenses, all in, you need, call it $4,000 a month. That's what you need to pay for everything and have enough, a little extra to put towards the side. You don't want a lot to put towards the side ... not from here at least, but let's say $4,000 a month cover is your safety fee, your safety net, your emergency expenses and can pay all your bills. Then what I would advise you to do is have yourself as an employee of the company and have your salary at $4,000 per month.
And what that means is whether you pay yourself every two weeks or whether the first that every month you get yourself a paycheck, it's consistent. It's $4,000, that is your salary to be the CEO, or President, or whatever you want to call yourself of your company. All right, so I'm taking out the calculator here and what that means is if you pay yourself $4,000 a month salary, then in a year, over 12 months you are making $48,000. Now, you might be thinking, "Anton, you just said that I made $250,000 in net profit in my business, why am I only making $48,000?" That's because that's what you need to cover your expenses, and that's enough. That's a reasonable salary for somebody to be running your business. And by the way, the IRS does look at this. You need to be paying yourself a reasonable salary for the job. And you'll see why in just a minute because this could be a loophole for people that try to exploit it, but those people get in trouble. So don't be that person.
But now what we're looking at, out of your $250,000 in net profit, after you took out your 48,000 salary is $202,000 that is in your business bank account at the end of the year, if that's how long you wait to pay yourself. But this is what is leftover as ... I'm just going to write BP for business profit. Now, how do you take that? Well, as an S corporation, what you can do is take it as a distribution. Like I mentioned earlier in this podcast, distributions are taxed differently than salary. Salary has different expenses that come out of it, like social security, like Medicare. Distributions do not have those same taxes associated with them. So yes, you're still paying tax on it, but you're saving yourself about 15% in Medicare and social security. Okay? So that's why this is important. And like I mentioned, that's why the IRS doesn't want you to say, "My salary is a dollar per year and everything else is distribution." Because that's not fair, that's cheating the system. So don't do that.
Now with that being said, do you have to wait until the end of the year to take this out? Or even if you don't take it out, to pay tax on it? And the answer is no, and I also don't think that you should. So remember the money you're paying yourself every month, the 4,000, that's enough for you to cover your expenses. That's enough for you to have a safety net, some extra money. So in case things go bad, your family has money. But with the money that your business is making, I want you to take distributions throughout the year. It'll be more annoying for your accountant, but you could technically take a distribution every day of a random number and it's fine as long as it's all reported when you're paying your taxes. With that being said, the way that I think is best to do it is set quarterly goals for your business in net profit and choose a distribution that you want to pay yourself every month based that. So an example might be in Q1, I want to do $100,000 in net profit.
And if we hit $100,000 in net profit, I'm going to take $50,000 as a distribution. So basically there, you would have your $4,000 a month. That's your salary. Plus you would have a huge distribution of 50K for a Q1 if you hit your goals. Now, the rest of the money is still going to be in your business, it's still going to stay there. So that at the end of the year, if you don't need it by then, you can take it as distribution. But I like to set different goals monthly and quarterly, and when they're hit, take distributions based on numbers. It's really motivating and it's a good way to know why you're taking money out of the business. Now, I do recommend leaving money in. So, again, I don't recommend just taking all the money out as distributions as quickly as it comes in. There's a couple of reasons for that. One is because the best use of money is not to take it out and just pay tax on it right away, it's typically to reinvest it into your business because first of all, it's a write-off.
Second of all, it can grow your business faster. So in that example I just gave, if you hit in Q1 $100,000 net profit and you paid yourself 50,000 distribution, that other 50 I don't want to just sit there. I'd want to see you try different things with that. Maybe creating a different physical product brand, maybe using different ads. Maybe scaling your ads that are working. And don't just throw it away, but try to use it wisely in a way that will grow your business. Don't just pull all the money out just to pull it out, try to grow and use it as fuel. So the benefit there is Q2 should be even bigger. And also because that money is being reinvested into the business, it's a write-off and write-offs are the next way that you should pay yourself. So kind of confusing for a lot of people when they're first starting, like, "What is a write-off? What's not?" Again, talk to an accountant to get somebody to sign off on this.
But if you're doing something like trying to learn more to grow, and you're doing things like investing in courses, whether online or in person, if you're joining masterminds, if you're going to business conferences and you're buying tickets and traveling, those things should be write-offs. They should be coming out your net profit, not after you pay yourself a distribution, then pay it out of your personal account. They should be paid through the profit in your business. So again, the reason we're doing this is because it helps us to save more money on taxes, the money is coming out of the business rather than getting taxed and then having us spend it. So whenever it's possible to write anything off and charge it through your business, you definitely want to do that. With that being said, I want to make sure as you're doing this and as you're getting more advanced with finances, and paying yourself, and distributions, and write-offs, make sure you're taking really good care of tracking everything and of your books.
The tool that we use to do this is called Xero. It's spelled X-E-R-O. It's an app online basically that links to all of our accounts that tracks money going in and out. And you really want to be tracking your write-offs because not only so you know how much of this extra money you're really making ... Because you're using it for yourself, but through the business as an expense. You want to know how much is actually there so you know for your own records. But also, so if you ever want to sell your business, which ... Who knows? When I first started, I never thought I'd sell businesses and I've sold a good amount of them. So you never know what's going to happen. But when you go to sell your business, all of those write-offs actually can get added back in to the profit and then your business can be sold at a valuation of the actual net profit plus any of those write-offs that came out.
And the reason is maybe the new owner of the business doesn't want those expenses. Maybe they're not going to go to a mastermind, maybe they don't have to lease a car through the business. So just make sure, again, you're tracking it. It's everything's good for you, for the IRS, and for the future valuation of your business should you want to go sell it. So, I hope that makes sense, guys. I know I used some bigger numbers here, but honestly, even if you're doing half a million a year in sales and you're doing 125K in net profit, you still do want to use this method. It'll save you money in taxes. It'll give you different quarterly goals that you can really shoot for because you'll know you'll give yourself a big bonus. And it'll help you be able to put all the expenses possible through your business so that you're not paying tax twice.
I hope you found that helpful. As always, if you did, please do go to Apple podcasts and leave us a review. I will leave a link to how to do that in the description. And if you're just getting started, you want to find out how to build a highly profitable semi-automated store. Go to dropshipwebinar.com to check out my coaching program. I will link that in the description as well. So thank you everybody. I appreciate you, and I'll talk to the next podcast. See ya.
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