If you asked most people how much they would pay themselves if they could set their own salary, you’d probably hear a lot of 6 or 7-figure numbers being thrown around. But when you’re the owner of a small business, that question becomes very real, and is much more complicated. There are a lot of questions that you might be asking yourself, like should I start out paying myself? Should I pay myself regularly, like an employee? How do I pay myself and how much? The answers to these questions, while they might vary from business to business, are actually fairly straightforward. The following tips will clear up any confusion so you can get excited about taking home your hard-earned salary!
Don’t Be Shy: Pay Yourself!
That’s right, don’t undervalue yourself and the work you are doing as the owner! No matter where you are in your business’ journey, don’t forget (or choose not to) allow for your own salary in your budget. While your salary should come out of your business’ profits, not revenue, you should take some salary even if you’re turning a very small profit.
There’s no point in creating financial hardship for yourself in order to prop up your business. You will only end up stressed, which will affect your productivity and decision-making skills. When at all possible, take what you need to live comfortably, or at least take what you need in order to avoid problems in your personal finances, while still avoiding financial problems for your business. To figure this out, think about:
- Your personal monthly and yearly expenses – start with only the essentials, including your purchasing habits and daily expenses
- Your business’ profits – If you take out the amount above from your profits, will you still be able to cover your business’ current, and very importantly, future expenses? If so, great! That’s your bare minimum salary, and you should try to stick to it, at the very least.
Take “Reasonable” Compensation
While paying yourself from the get-go is important, you also need to know how to determine what is a “reasonable” amount to pay yourself, and when it is smart to actually limit your salary and use that money in other ways. As we have pointed out, your salary should come from the profits of your business, but you shouldn’t automatically assume that all of the profits will go back into your pocket as pay. In fact, according to the Small Business Administration, most small business owners pay themselves 50% or less of their profits.
In addition, the IRS actually has the expectation that you will pay yourself only a “reasonable” amount. What do they mean by that? Well, it varies from business to business, but some things to consider when determining your “reasonable” salary are:
- How much would a company similar to yours pay an employee if they were doing a similar job to yours?
- How many hours do you work, and is your pay directly related to that amount of time?
- What duties are you regularly performing, and are your wages equal to those duties?
- Does your pay seem reasonable when compared to your employees’ salaries, if you have employees?
- If you saw an ad posted by a recruitment agency for a job similar to yours, would your salary seem to fit in that ad?
If you’ve thought about all of that, and perhaps talked with other small business owners about their level of compensation, then you should be confident that you’re not paying yourself too much. But there is one other thing to consider: whether it’s wise to pay yourself more in the short-term, and risk losing an opportunity for growth in the long-term.
For example, let’s say you’re turning a profit and you choose to add $5,000 a month to your salary. That’s 60,000 extra dollars to enjoy right now. But would it be worth it? Think of it this way: that’s money you wouldn’t have to put towards ways to grow your business and make more profit. If you used that $60,000 to hire a salesperson, for example, to take over some of your sales duties, that salesperson could end up making 10 extra sales. Those sales could mean $250,000 in revenue, and $100,000 in profit. You’d end up with more profit to pay yourself from, your hourly wage would be more valuable (since you’d be working less), and you’d have more free time – and what business owner doesn’t need more of that?
Know the Best Payment Method for Your Business Type
So now that you have the tools to figure out your minimum salary, as well as some strategies for keeping your compensation “reasonable” and smart, you need to know how to actually pay yourself. This depends on a few factors, most notably your business entity type. There are two main ways to pay yourself:
- Owner’s Draw – This is an option only if your business entity type is a sole proprietorship, an LLC, or a partnership. In these cases, the IRS views you as self-employed, so you don’t need to pay yourself a regular wage. Taking an owner’s draw simply means that you can withdraw profits generated by the business, or take out funds that you’ve previously contributed to operate the company, to pay yourself. An owner’s draw may also be a combination of profits and capital contributed. This money is then considered taxable income on your personal tax return. The money won’t have taxes withheld at the time you draw it from your company, so you’ll need to put money aside for when tax time comes around.
- Salary – You can also choose to pay yourself a regular salary, or a recurring payment that is taxed by the government. If you own a C corporation or an S corp, then you have to pay yourself this way; if you own an S corp, though, you have the option of taking a draw in addition to your salary. The advantage of choosing to pay yourself with a salary is that your wages will be automatically taxed, so there’s no estimating and saving involved. If you choose to go this route, make sure you have some good payroll software to keep things running smoothly.
There is so much to think about when you’re the boss, and your own pay can seem like another stress factor. But remember, that’s the exciting part! This is what you’ve been working for – to see your dream come to life, and then turn into a profit that you can take home and enjoy. With the tips we’ve laid out above, you can take the stress out of paying yourself, and get back to work – and enjoying the fruits of your labor!