The opportunity to pursue a lifelong dream is one of the top reasons entrepreneurs would likely give you if you were to ask them why they want to start their own small business. However, the ability to make their own money should not be too far down on their lists of reasons, either. This is why the concept of setting your own salary as a business owner is so essential. You don’t want to pay yourself too much, but you need a livable wage at the same time. So how can you determine the best amount to write yourself on your own paychecks?
The main dollar figure you should have your eyes on to set a reasonable salary for yourself is your business income amount. Remember that during the startup phase of any brand new business, you will likely need to put a limit on the amounts you put on your paychecks in order to have adequate funds to build the solid foundation you need for your small business. However, upon generating a decent cash flow, you’ll be able to pull out a percentage of the money for yourself.
Over time, research has shown that owners of small businesses who have experienced profitability normally set aside up to only 50% of the money their businesses generate for their personal salaries. In terms of when you should pay yourself and the regularity of writing yourself paychecks, many business owners find that doing so monthly works very well. However, it obviously varies from one entrepreneur to another and depends largely on how quickly you build up your customer base. Some small business owners can reach into their business bank accounts for personal funds on a biweekly basis, while others may only be able to do this every 2 or 3 months. The good news is that you should be able to pay yourself more frequently as time goes on.
Not all small businesses are run by one woman or man. As for those that are – commonly known as sole proprietorships – this type of business structure comes with a fairly straightforward approach when the owners of sole props attempt to set a salary for themselves. Essentially, all business income at play is ripe for the business owner’s taking. Of course, it would not be the smartest move to claim 100% of this income as a personal salary due to business expenses, business taxes, and other goods or services you must budget for. A basic salary formula for owners of sole proprietorships is to add up all income and then subtract business expenses and taxes from the income amount. The resulting amount you get should be a reasonable estimate of your salary as a business owner.
When putting a dollar figure on the salaries for small business owners who work with one or more business partners, or for those with employees, the salary proposition gets a little more challenging. In such cases, it’s critical to look over any data you have related to your previous and current profit earnings. Make adequate and reasonable projections on future earnings that you think you can make in 3 months, 6 months, a year, 2 years, and even up to 5 years down the road. After making these estimations, account for your current and future business expenses, determine how much you’ll pay your employees or contractors, and then finally calculate what you’ll be able to pay yourself.
In IRS lingo, the term “fair and reasonable salary” is typically applied to owners of LLCs and corporate entities. What this means is that you should compensate yourself with an amount that is fair for your type of work yet within reason at the same time. If you pay yourself too much, the IRS may take issue with this number when you file your tax return.
Business finances and business taxes are no joke. Both play a significant role in setting your salary as a business owner. With that said, it is best to seek advice from an accounting professional or financial planner to ensure you are paying yourself enough yet keeping enough money in the business to spur growth over time.