One of the most common struggles for small business owners is determining how to pay themselves. Often, it’s an afterthought – which can come back to bite you when money is tight.
If you’re a small business owner, this is how you should pay yourself.
Types of Compensation
There are a few different ways that business owners can pay themselves, and the right approach depends on your business size, number of employees, revenue, and your needs.
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An owner’s draw is essentially just taking money out of the company to pay yourself. This can work well for business owners who don’t operate on a 40+ hour per week schedule and don’t need consistent pay. For example, if you only work 20 hours a week then you may take less money.
However, the danger with owner’s draw is that inconsistency. It’s very easy to both underpay yourself or to draw too much money from the business. It also can make it harder to budget effectively, especially if you’re deciding your compensation month-to-month and it changes dramatically.
Even with those limitations, owner’s draw can still be the right choice in certain situations. If you’re just launching your business and aren’t out of the red, paying yourself via owner’s draw makes sense. If you’re sole proprietor, owner’s draw typically makes more sense over salary.
Salary is a more typical compensation strategy, where you pay yourself a set amount each year.
Consider a salary once your business has sustained revenue, consistent projected revenue, and is in the black. Many business owners are hesitant to give themselves a salary, but it’s typically the best approach, for a few reasons:
- Salary is more equitable if you have co-owners
- It ensures consistency, which makes budging easier
- There are a number of tax incentives
- It’s a requirement for S-corporations or C-corporations or a limited liability company taxed as a corporation
The next step is deciding what a fair compensation is. The IRS requires that compensation be reasonable: “Wages paid to you as an officer of a corporation should generally be commensurate with your duties.” In other words, look at the average salaries of similar jobs to what your duties entail to determine a reasonable salary.
Salary is also different from owner’s draw in how taxes are paid: with a salary, taxes are deducted up front. With owner’s draw, you’ll need to keep track of what you pay yourself and then pay taxes during tax season.
So which option is right for your company? It depends! Greater Midwest Financial Group can help find the best solution for your specific needs. Contact us today to get started.
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Greater Midwest Financial Group is a financial advisor firm serving St. Paul, Minneapolis and the wider Twin Cities area. We specialize in wealth management, retirement planning, asset management and other personal finance needs.
LendingTree, “How to Pay Yourself as a Small Business Owner ”
Business News Daily, “Entrepreneur Salaries: How Much Should You Pay Yourself? ”
IRS, “Paying Yourself”
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