How to Pay Yourself When You Own a Business
As a business owner, you have complete authority over your finances. You can decide how much to invest in daily operations, how much to spend on marketing and even how much to pay yourself.
But as they say: with great power comes great responsibility.
With no one guiding you, finding the fine line between rewarding yourself and investing in your business can be difficult. You want to balance the business’ growth but also give yourself the financial strength to make better decisions.
If you’ve ever struggled with figuring out when, how and how much to pay yourself, this post will help you out.
Ways to Pay Yourself
While a monthly salary is obviously a widely accepted and easily understood way to pay yourself, there are a number of alternatives as well, each with their pros and cons.
If your business is registered as a corporation
In some corporate structures (such as an
- Monthly salaries are predictable, stable and make for easier accounting.
- Getting a salary means that you can invest in retirement plans such as a 401k or Canadian RRSP.
- Salaries are 100% taxable, so this might increase your tax burden depending on your country and tax bracket.
- In some countries, you are liable to create a payroll account with the tax authority to pay yourself.
Apart from salaries, a popular way to pay yourself as a corporation is through dividends. A dividend is essentially any profit extracted from an incorporated business after all its liabilities (including tax) have been taken care of.
Dividends can be extracted as many times and in as large an amount as necessary — provided it is approved by all shareholders.
A lot of business owners prefer to pay themselves small salaries then make up for it by regularly extracting dividends from the company.
- Dividends are usually taxed at a lower rate than wages, so you’ll save on taxes.
- If you pay yourself in dividends, you might not be liable to pay for mandatory government pension schemes.
- It is usually easier to pay yourself in dividends — you can write yourself a check and make a record via a director’s resolution.
- Dividends don’t count as personal income. This might disbar you from investing in saving instruments like the 401k or Canadian RRSP.
If your business is registered as a proprietorship or a
Since the proprietorship is considered to be wholly owned by you, you can draw as much and as frequently as you want. Drawing money from the business reduces your capital account (among you’ve invested in the business).
- It’s very easy to pay yourself — you just have to write a check and deposit it into your personal account.
- No social security/Medicaid or federal/state taxes are withheld on draws, though this might vary from country to country.
- If you pay yourself entirely via draws, you don’t have any personal income on paper. This can cause a problem when applying for mortgages or personal loans.
- Any draw you take out is taxed as personal income. This can be higher than corporate taxes in some countries.
Most business owners prefer to pay themselves via a mix of salary + dividends/draws. A regular salary ensures that you have a consistent source of income. Any additional profits you want to extract can be done via dividends or draws.
Also keep in mind your country’s taxation structure. In Canada, for instance, if the business makes more than $500,000 in profits, it doesn’t meet the Small Business Limit and gets bumped to a higher tax bracket. Some business owners prefer to pay themselves a higher salary to cut down profits below the $500k limit.
All this can be complicated. Instead of figuring out the best method yourself, consult a trained accountant.
How Much to Pay Yourself
This brings us to the meat and potatoes of this post: how much should you pay yourself? Your salary will depend on a number of factors — industry norms, profitability, tax structures, etc.
How much you’ll pay yourself depends on the established norms in your industry. Even the IRS expects you to pay yourself a reasonable compensation that’s aligned with industry standards.
To give you an idea, the median wage for top executives is $103,950, according to the Bureau of Labor Statistics.
Of course, this figure is skewed due to a large number of overcompensated corporate CEOs, but it is a fair assessment of the worth of a founder/CEO.
Ask your friends and acquaintances in the industry about their own compensation. Come up with something similar (as long as it doesn’t impact profitability).
Your personal income requirements
When your business is in its infancy, it makes sense to reinvest as much of the profits into the business as possible. Even when you do decide to take a salary, you should strive to keep it as low as possible.
One way to come up with this figure is to do a close audit of your personal expenses and create a personal balance sheet. This is the minimum amount of cash you need each month to live.
This should include:
- Rent and utilities
- Groceries, fuel, dining out, etc.
- Debts including existing loan and credit card payments
- Monthly, quarterly, annual payments such as car insurance, medical insurance, etc.
- Average monthly miscellaneous expenses
Your salary should be at least 10% higher than all these expenses combined.
Salaries at equivalent positions
The IRS expects you to pay yourself an amount equivalent to what a person in your position would make in a typical business.
This can be a good guide to figuring out your salary. Look at job openings and Payscale reports to check average salaries for employees with similar skills as yours. Avoid comparing yourself to
Here’s what Payscale says is the average income for a CEO. Note how CEOs make a lot of money through bonuses and profit sharing:
Instead, look at
When calculating your own salary, add a premium because your responsibilities will usually extend beyond a typical employee’s. Remember that you don’t always have to be the highest paid person at the business. There can be employees who make much more than you as well.
Your business legal structure
As we talked earlier, different corporate structures offer different ways to pay yourself. Tax rates also vary based on how you’re incorporated.
This will be a major factor in deciding how much you pay yourself. For example, if you are incorporated as an S or
The important thing to note is to pay yourself legally. Outside of a proprietorship (where you can pay yourself via owner’s draw), you shouldn’t dip into the business funds randomly. There should be a proper record of any money withdrawn from your business account to your personal account (either via salary, bonus or dividend). Else you risk an IRS audit.
Consult an accountant to understand the most
Any money you take out of the business has an opportunity cost. You cannot reinvest your salary in a profitable promotion.
Opportunity cost is the loss of other alternatives when one alternative is chosen.
If you have any such existing opportunities, it makes more sense to maximize the opportunity and minimize your own salary.
Consider an example: You’re running a successful Facebook ad campaign. For every $1 you put into the campaign, you make $1.5 back — a straight 50% profit.
Keep this in mind when figuring out your salary. If you can spot any such current or future opportunities, reduce your salary and put that money into the business instead.
Your salary before you started the business
Chances are, you worked a job before starting your
For example, suppose you were making $20/hour in your last job. This would give you an annual income of $41,600 at a standard 52 weeks of work.
Add a 10% bonus to this figure given your additional responsibilities as a business owner. Further, add inflation to the salary as well. This will make financial planning easier.
Thus, with an inflation of 5%, your salary would be:
$41,600(S) + 10% of (S) + 5% of (S) = $48,084
Think of this as your replacement salary, i.e. the salary at which you can replace your existing job.
To Sum Up
Ideally, you should pay yourself a salary only after you have sustainable, scalable profits.
Once you do decide to pay yourself, choose the most
How do you calculate your salary? Share your method with us in the comments below!