Are You Paying Yourself Enough (or Too Much)?
How To Determine If Your Salary Is Fair
For many business owners, their compensation is determined by how much cash is left after all the bills have been paid. But this approach can backfire.
“When a business is in survival mode, the owner may not be thinking clearly about his or her income and neglect to plan appropriately,” says Paul Dorf, managing director at Compensations Resources, Inc., a compensation consulting firm. “But he or she should plan for their compensation as they would for any other executive.”
What Is Your Fair Pay?
One option is to take a percentage of the profits. According to the Small Business Administration (SBA), many small business owners limit their salary to 50 percent of the profits after taxes. When factoring the 50 percent, you may want to first allocate cash needed for future growth.
If your business is profitable and has a history of profitability, you can also plan your compensation as you would for any other employee. Determine the value you are bringing to the business. “Check comparable pay for similarly situated business owners. Online sites post salaries for certain positions (eg, CEOs or CFOs), which can be a starting point for crafting a salary amount,” says Barbara Weltman, publisher of Big Ideas for Small Business, author and tax expert.
When researching comparable salaries, look at privately held companies that are relatively the same size as your business and in the same industry. The location of the company may also impact salary rates. The SBA has a list of salary resources for small businesses.
Another consideration is the structure of your business. Tax implications vary depending on whether your business is an LLC, C-corporation, or S-corporation. Before you start cutting checks, consult your accountant or tax attorney to make sure you won’t send up any red flags with the Internal Revenue Service.
If your business goes through periods of unprofitability, and you forgo a paycheck, you can pay yourself additional compensation when the business is back in the black. “Arguments can be made for not taking a salary when the business isn’t profitable,” says Weltman. “Catchup compensation can be paid when it turns profitable.”
Can You Overpay Yourself?
While most business owners have gone without a paycheck so that they could reinvest in the business or make sure employees and vendors were paid on time, it is possible to overpay yourself. Taking too much cash for your personal income can hinder potential business growth, and as a result, limit your personal wealth, as well. “An owner can take out so much money that it can hurt the company,” says Dorf. “Rather than taking more money for himself, the owner might want to consider hiring a salesperson with that money because an additional salesperson can help generate even more profits the following year.”
One more thing to keep in mind is that owner compensation is more than just money. “In setting salary, take into account the overall compensation package (eg, use of a company car, retirement plan contributions, and other perks),” says Weltman. “Some of these benefits are taxable and some are tax-free. Work with a knowledgeable tax advisor.”
You should be paying yourself a market rate. If you consistently can’t afford to pay yourself, you may have to reevaluate the business.
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Topics: SMALL BUSINESS