Solving the Salary Puzzle
To keep more money in the business, some small-business owners avoid paying themselves. According to one study, only a little more than half of small-business owners pay themselves a regular salary.1
Of course, the size of the owner’s paycheck largely depends on the type of business and how well it’s doing. If the company is new or doesn’t have any employees, the owner’s salary might simply be what is left over after expenses and taxes. After a business becomes established, hires employees, or has significant profits to work with, the question of compensation becomes more complicated.
Here are some of the key considerations when deciding how much your business should pay you.
Does business structure matter? For sole proprietors and partnerships, profits from the business and personal income are treated the same by the IRS. A corporation is allowed to deduct salaries paid to employees (including owners) as a business expense, but compensation must be “reasonable” considering their roles and duties.
How much are you worth? Potential investors or creditors may be critical of the company’s prospects if the owner’s salary is too high or too low. It may take some research to determine and justify the market value of your time and contribution to the company.
Are there reasons to reinvest? Even if you are satisfied with the size and performance of your company, you might need to modernize equipment or facilities, or take other steps to remain competitive.
Is it time for a raise? Consider giving yourself annual pay increases (or bonuses) that are linked to the growth of the business. For example, if sales have surged 25%, multiply last year’s salary by 125%.
What about benefits? You may be able to lighten your tax burden by deferring some salary and contributing to a qualified retirement plan. It may also be worthwhile to fund other types of workplace benefits such as life, health, and disability insurance for both you and your employees.
Whatever approach you take, it’s important to strike a balance between the business’s needs and goals and your own.