How Do Business Partners Get Paid?
As a business owner, you want to make sure you can pay your own bills, set yourself up with financial health, and even take a break here and there. This means personal income, and it’s impossible to live without. But how can you get paid as a small business owner, a partner, or a shareholder of a corporation?
How your business type affects how you get paid
How your business is structured will directly impact how you get paid. Not all business structures pay the same and how much you earn depends on the state of your business’s financial health. For many small business owners and entrepreneurs, this might mean lower personal income. There are different requirements for filing and paying taxes for each business type, which will also affect how you get paid.
Let’s look at how each business structure works and which type would work best for you.
A sole proprietorship is the simplest business type, generally encompassing newer entrepreneurs and small ventures. When it comes to your personal income, sole proprietorships offer both pros and cons.
As sole proprietorships are not legal entities, all the decisions and responsibilities are solely the owner’s responsibility. This can be really beneficial if your business is booming, but it also means all finances rest squarely on your shoulders. Labour and overhead costs, procuring capital, and debts are all your personal responsibility.
A sole proprietor is not an employee, but rather you are a self-employed entrepreneur. This affects your personal income tax as the profits are all yours. For tax purposes, this exposes you to potentially quite a few tax write-offs such as transportation, part of your living expenses if the bulk of your business is conducted from your home, including internet, hydro, gas, and the like. These are personal tax credits, which are all rolled into your personal tax return (self-employment tax return). While this is not direct income, it does increase the money your business gets to keep and therefore, you can choose to draw an income from it or reinvest it back into your business.
As sole proprietorships tend to be fairly small businesses, you might not get paid for a while until your venture gets off the ground. Budgeting for this should be done at the outset. A business plan can help you with this.
One of the biggest drawbacks to a sole proprietorship is the unlimited liability. You personally have no liability protection, and any debts or litigation will expose your personal assets like real estate, vehicles, and even savings and reduced credit rating.
Partnerships vary slightly from sole proprietorships in that there are two or more partners invested in the business as owners, and the legal requirements of a partnership are clearly outlined. While a partnership is still not a separate legal entity, and the partners are also personally liable for business debts, how partners receive an income depends on a partnership agreement.
Similarly to sole proprietorships, partners’ income is directly reflective of the business profits. However, each partners’ income is set out in accordance with the partnership agreement and how much each partner has invested in the business, whether that be capital, labour, or other costs. The profit, if there is any, is then distributed among the partners accordingly.
Just as any contractual agreement, a partnership agreement can be written, verbal or implied. It is not difficult to form and does not require any registration process (unlike articles of incorporation). However, a business plan as part of the partnership agreement may be required if you’re looking to acquire any loans or grants.
Corporations are vastly different from sole proprietorships and partnerships in that they are their own legal entity separate from business owners. This provides shelter to business owners from any liability. This is often an attractive feature that influences business owners to choose to incorporate their business. As a legal entity, the corporation files and pays its own income taxes separate from owners and shareholders.
All of this impacts how owners receive an income. A corporation can raise funds from investors and shareholders and may be eligible for larger loans.
The structure of a corporation is maintained by a document called articles of incorporation, mentioned previously. It sounds scary, but it’s really not. Articles of incorporation can look like partnership agreements, the difference being that articles of incorporation are mandatory under law, whereas formal partnership agreements aren’t necessarily mandatory.
Articles of incorporation set out partners’ roles, some of which are legally required to keep a corporation status, shareholders’ income (that’s you!), possible bonuses on profits, and other business structures.
Like sole proprietorships and partnerships, how much partners get paid depends entirely on the business’s financial health.
Draw vs. distribution vs. dividends
Business owners’ draw, distribution and dividends are the primary structures of how business owners are paid. Sole proprietors are paid via a draw, partners take a distribution, and corporate shareholders receive dividends of the profits.
These terms can seem confusing, particularly for a new entrepreneur looking at the legal definitions! We’ll break them down for you to help you make the best decision for your business.
Sole proprietors take a draw
Sole proprietors aren’t employees and therefore, don’t earn a salary. That doesn’t mean they don’t get paid. Sole proprietors take a draw from the business, which comes from your own capital (ownership) account (i.e. how much money you’ve put into the business). This is a direct payment and is quite different from a distributive share or dividend, particularly for tax purposes.
A sole proprietor draw isn’t claimed on business income taxes but rather on the business owner’s personal income tax return. Don’t forget, a sole proprietorship isn’t a legal entity and can’t technically file taxes.
Partners take distributions from profits
Like sole proprietors, partners don’t get paid via a regular salary but rather earn distributions of the business profits. These dividends are generally set out in the partnership agreement (if they aren’t, you may want to think about drawing up a partnership agreement that outlines distributive shares).
While the income you receive as a partner may be similar to a sole proprietor’s, it is based on the individual share of income, gains, losses, and credits or deductions. These can vary widely from year to year, and hence so can your payments.
Like sole proprietorships, a partnership is not a legal entity, so any distributions will not be accounted for in business tax returns but rather your own personal tax returns as a self-employment tax. This will also reflect the business’s profits and losses.
The tax process is a little more complicated for a partnership. The forms are available on the Canada Revenue Agency website. This may also be one of those situations where outsourcing an accountant well-versed in partnership taxes might be a wise idea!
Corporate shareholders receive dividends
Like sole proprietorships and partnerships, corporate shareholders don’t technically earn a salary but receive dividends. Dividends are a portion of the profits of the business and can fluctuate from year to year. How much each shareholder receives is set out in the articles of incorporation. If there is any surplus money not received as dividends, this money is reinvested into the business.
Taxes are different for shareholder dividends primarily because the business is a legal entity and holds the same legal responsibilities of a person (yep, like paying your own taxes). Taxes on dividends you receive as a shareholder are your responsibility. In Canada, the dividend tax credit allows for lower tax rates on your dividend, and that can put money in your pocket.
How much should a business owner get paid?
Regardless of your business structure, you can technically earn as much as you want…with a caveat. If you take too much, you won’t have a business and could potentially run into problems, debt being one of them.
It can be difficult for small business owners to sort out how much to take from your business as your personal income. Often, this can be a fairly emotion-filled decision, particularly for small business owners. On the one hand, you want your business to flourish and taking any money from that might feel like you’re not making the best decision for your business. On the other hand, however, you need personal income to cover your own cost of living and maybe even have your own nest egg for you or your family.
Start with a business plan. If you already have one, take a good look at it and see how representative it is to the actual health of your business. Whether you’re a sole proprietor or in a partnership, a business plan is essential. With a corporation, a business plan will be part of the articles of incorporation, and can often involve the input of more than two people.
Your business plan should cover how much money is needed to pay employees, cover overhead like lease payments and utilities, income taxes, and a health forecast of profits and losses. If you’re a new small business owner, forecasting might be a challenge as you have no track record of income. Try to connect with other small business owners for some advice or follow other entrepreneurs in the same market as you on social media and in forums.
And don’t forget, forecasting must always include funds for rainy days!
Your business plan will give you a fairly good overview of your business’s financial health and available cash flow. With the surplus profit, ask yourself how much you want or need to reinvest back into your business. Reduce that figure from the available cash flow, which will then give you an indication of what you can reasonably draw or receive in distributions or dividends.
Whatever your decisions are for your budding business, Ownr is here to help you every step of the way! Register your business with Ownr and take advantage of all the perks that come with it.