You’ve started your business. You’ve begun gathering your client base. You’ve hired your staff. You’ve laid out your business plan. You have all things in order, but one: How much do you pay yourself in your own business?
This is a question central to all business owners. The IRS recommends that small business owners pay themselves “a reasonable salary.” But what does that mean?
Many small business owners often put their workers ahead of their own personal financial gain. After all, you can’t reduce their pay, but you can with your own during slow times. During the good times, however, you can splurge on yourself. Those are both the pitfalls and the perks of being your own boss.
To help you decide how much to pay yourself, here are a few things to consider when making that decision.
Figure out your business expenses and taxes, then you’ll know your salary
When determining your own salary, you should always figure out your business expenses and account for your taxes first, then you’ll know your pay range.
There is no set answer as to how much you should make. Basically, you should live small at first, then expand your pay as your business grows. You can say you’re going to pay yourself 50% of all revenues, but if your business expenses take up a majority of your profits, that’s not going to be possible.
To get a rough estimate of your salary, you need to figure out your net income then subtract your taxes. Net income is your gross (overall) revenue minus your business expenses.
Business expenses can include all of your overhead costs, such as labor and insurance costs for your workers, plus any other expenses that may add up. These can include material costs, marketing costs, building costs, meals, fuel, and more. Be sure to also include any business debts or loan payments when budgeting your salary. These are business expenses as well.
To project your business expenses, take your average business costs over a few months and extend it through the rest of the year. If your business is seasonal, take into account for those potential ups and downs.
Once you have your expenses figured out, don’t forget about your taxes. If your business is profitable, you should set aside at least 30% of your net income for taxes. If your business is not profitable, the losses can be written off. But don’t count on that. If you lose money enough, you'll be out of business altogether.
Once you’ve budgeted your business expenses and taken into account your taxes, you’ll get your profit number. Profits are where you pay yourself.
Be prepared to live small your first year
Most small business owners don’t take in much of a salary in their first year of operation. There’s payroll to make, there are startups costs to worry about, and you’re in the process of building a client base. So be prepared to live a little lean in that first year.
If you make a little bit more, go ahead and give yourself a raise. Just make sure you can cover all that you need to in your business’ initial phase. You may have to forgo large personal purchases at first. You don’t want to miss any payments or have to let go of workers early on.
Decide how much of your profits you want to go toward your lifestyle
The average small business owner in the U.S. makes about $75,000 per year. Depending on the success of your business, that number could seem high or low to you. No matter what you make, you should decide how much of your profits you want to keep for yourself or re-invest elsewhere.
Think about it - can you sacrifice some of your profits to put toward a retirement account or other long-term investments? Do you really need that new car or can you put that money back into your business to help it flourish? These are decisions you’ll have to make. A little extra money could go toward more marketing or the expansion of your business.
There is no right or wrong answer for how much to pay yourself. As long as your business is profitable and you can pay all of your expenses, the choice is ultimately yours. After all, it’s your business, you can do with it as you wish. Just make sure you’re comfortable with your decisions and how you spend your hard-earned profits.
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