As a business owner, it’s important to prioritise not only paying your employees and investing in your business but also ensuring that you pay yourself. Determining the best approach to compensate yourself while considering business debts and taxes is crucial. Here, we will explore different methods for paying yourself and provide tips on calculating your salary and determining when and how to pay yourself.
Ways to Pay Yourself
There are two common ways that small business owners can pay themselves:
1. Salary: Opting for a salary allows you to pay yourself in a manner similar to your employees, including withholding taxes. When calculating your salary, you can use comparable positions in your industry as a reference point. Keep in mind that the IRS may evaluate your salary against similar roles to ensure it is reasonable. This method is typically employed by owners of corporations (S corps and C corps), who are taxed on both their personal income from the company and the reported profits of their business.
2. Owner’s Draw: An owner’s draw involves transferring money from your business’s profits to yourself as needed. While you won’t need to pay taxes for each draw upfront, you will be responsible for self-employment taxes either quarterly or annually when you file your tax return. This payment method is commonly used by owners of pass-through entities such as sole proprietors, partnerships, and most limited liability companies (LLCs).
Tips for Setting Your Compensation
To ensure that you establish appropriate compensation while considering other financial aspects, consider the following tips:
1. Calculate Your Net Income: Begin by calculating your net income, which involves subtracting your business expenses (e.g., employee salaries, office rent) from your gross revenue. After setting aside the necessary amount for taxes, determine your pay based on the remaining figure.
2. Factor in Taxes and Savings: It’s essential to plan and save throughout the year to avoid accumulating tax payments. Consult with an accountant to understand the tax obligations specific to your business and prevent any penalties. Depending on your circumstances, you may be required to submit and pay estimated quarterly taxes.
3. Account for Business Debt: Once tax payments have been accounted for, allocate funds to address your business’s debt obligations. If you have loans or credit card debt, deduct the minimum payments from your net monthly income. If there is surplus funding after paying yourself, consider increasing your monthly payments to expedite debt repayment.
4. Establish a Business Savings Plan: Building a savings buffer is crucial for accommodating new hires, training programs, or emergency funds. Determine your priorities and allocate funds accordingly. Dividing your goals into monthly savings will help you effectively manage your finances.
How Much Should You Pay Yourself?
Once you have considered the aforementioned factors, you can determine an appropriate salary for yourself:
Deduct all the necessary allocations mentioned earlier to calculate your annual salary.
Divide your annual salary by 12 to determine your monthly salary or by 52 for your weekly salary.
Further divide your weekly salary by the number of hours you work to establish your hourly pay rate.
Remember that paying yourself excessively could hinder the growth of your business, while not paying yourself adequately may impact your personal financial stability. Striking a balance between a livable salary and supporting your business’s growth is essential.
