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What should your small business owner salary be? Unfortunately, the answer isn’t “whatever you want it to be.” How much to pay yourself depends on your stage in business, the form of your business and your business’s profitability.
If your business is just starting out, you may think you can pay yourself nothing and live on your savings while the business gets off the ground. In reality, however, it’s important to pay yourself something—first, to prove to the IRS that your business is a real business and not a hobby, and second, to create accurate financial projections.
If your business achieves break-even or profitability based on your not taking a salary, that’s not an accurate measure of success. In particular, if you’re seeking any type of financing—such as a bank loan, private investment capital or venture capital—potential funding sources will want to see that your business can pay all of its overhead costs, including owners’ salaries, and still make a profit.
As a startup, you can determine your salary based either on 1) the minimum you need to meet your basic living expenses (with no frills attached) for six to 18 months until the business breaks even or 2) what you are worth in the marketplace.
The second method is easier in the long run, because if you start out with a fair salary, you can keep paying yourself the same amount once your company becomes profitable. However, if your startup can’t support paying you market worth, it’s OK to pay yourself the bare minimum until your business breaks even. After that point, you can increase your take-home pay by giving yourself quarterly bonuses based on the company’s profitability. Once your business is showing steady profits, you can increase your salary.
A small business owner salary also depends on the company’s structure.
If your business is a sole proprietorship or partnership, figuring out how much to pay yourself is simple. That’s because the IRS treats the business’s profits and a sole proprietor or partner’s personal income the same. In other words, after you’ve deducted business expenses on Form 1040 Schedule C (for sole proprietors) or Form 1065 (for partners), the remaining profit is considered personal income.
That doesn’t mean a partner or sole proprietor can’t get a salary or that you have to wait until tax time to pay yourself. Based on financial projections (if you’re a startup) or past financial performance (if you’ve been in business a while), you can estimate your business’s profits and set up a consistent salary for yourself and/or your partners. If your business does better than expected, you can give yourself and/or your partners a quarterly or annual bonus, too.
If your business is incorporated, things are a little different. Since you are an officer of your corporation as well as an employee on the payroll, you have to pay yourself a salary or wages, which must be “reasonable compensation” according to the IRS—neither too much nor too little.
Some business owners use the business’s money to pay their personal expenses without taking a salary in the belief this will save them on taxes. But this tactic can backfire and lead to substantial penalties if the IRS decides the money should have been taken as a salary.
If your business is a corporation, the best way to go is to determine the average rate for CEOs (or whatever your title is) in your industry, your region and for companies of similar size. You can get this information from your industry trade association, or from sites such as Glassdoor.com or Salary.com (disclosure: Glassdoor.com is a client of my company).
Keep in mind that salary and compensation can be complicated by factors such as whether your business has investors and how many shares of the business’s stock you own. Review the IRS’s guidelines and frequently asked questions about small business owners’ salaries, and consult with an accountant before setting your salary.