How Do I Take a Salary for Myself as a Business Owner?
Taking a salary as a business owner is not as simple as declaring you’ll start paying yourself a certain amount of money each month. Many factors, including the entity formation you incorporated as and your company cash flow, play a role in drawing an appropriate salary.
GOBankingRates spoke with Thomas Prevatt, partner at Aprio, on the best practices for paying yourself as a business owner.
Support Small Biz: Nominate Your Favorite Small Business To Be Featured in GOBankingRates’ 2022 Small Business Spotlight
Read: 22 Side Gigs That Can Make You Richer Than a Full-Time Job
When Are Business Owners Ready To Start Paying Themselves?
Many business owners delay paying themselves when first starting a small business. This decision is usually tied to cash flow. Prevatt said that owners want to ensure there is enough cash to pay for major business expenses, suppliers and employees before they pay themselves any leftover cash.
However, Prevatt recommends owners start paying themselves from day one of being in business. Doing this helps start the mindset of paying yourself early on. The amounts may be small at first (we’ll dive more into the average compensation in a bit) and gradually increase over time as the business continues to grow.
“As an owner, the company should work for you instead of the other way around,” Prevatt said. “Forming good habits of paying yourself first, which means setting up accounts for yourself and your potential taxes as a result of the business income, is a great way to start things off.”
Find Out: Lala Kent Says the Key To Entrepreneurial Success Is Learning From Failure
Best Methods for Paying Yourself
There are a few popular methods for how business owners may pay themselves. Some of these include taking a salary (the business owner receives a set wage) or an owner’s draw (the business owner withdraws funds from the business for personal use).
Ultimately, Prevatt said the decision is determined by the entity structure you incorporated as. Here’s what payment methods might look like for the following three, popular business entities.
C Corporations
If you are incorporated as a C Corporation, Prevatt said business owners may use wages and distributions/dividends to pay themselves. Salary may be deducted as a business expense but is taxed to the owner as ordinary income. Payroll taxes, including FICA and Medicare, may be deducted as well.
Prevatt said that distributions to owners from a C Corp are taxed as capital gains to the owners. However, the corporation cannot deduct this payment which may lead to double taxation for C Corporations. This is where the C Corp pays tax on the income, and the distributions are taxed again when received by the owner.
S Corporations
Similar to a C Corp, business owners under an S Corp entity may use wages and distributions to pay themselves. Where an S Corp differs from a C Corp is that business owners are required by the IRS to take a reasonable salary. (Business owners may review the Wage Compensation for S Corporation Officers IRS document to determine reasonable compensation.)
Pravett said that like a C Corp, salary can be deducted as a business expense to the S Corp. FICA and Medicare taxes may also be deducted as well. Salary that is deducted as a business expense in an S Corp is taxed to the owner as ordinary income. This means S Corps are not subject to double taxation.
“The IRS states that the owner must have a reasonable salary before issuing tax-free distributions. You may consult your tax advisor on the salary/distribution mix that’s right for you and your S Corporation,” Pravett said.
Partnerships
Owners of partnership entities are not permitted to pay themselves through wages. Rather, Pravett said owners pay themselves by issuing distributions throughout the year.
Unsure of How To Pay Yourself?
Do not worry if you still have questions about the process. Prevatt recommends having a conversation with your tax advisor on how to structure your owner compensation within your business.
Is There an Average Small-Business Owners Should Pay Themselves?
Aside from reasonable compensation requirements set by the IRS, certain factors will determine how much a business owner is meant to pay themselves.
The most important factor is cash flow. Pravett recommends keeping owner compensation low or zero if you are investing back into the company, the company is in start-up mode or there are cash flow issues in the business. Remaining low or zero helps the owner reinvest in and build the business.
If the reverse is true, and the business has positive cash flow and is in a good place, business owners may look at other factors. Pravett uses the example of paying yourself while keeping taxes low.
“One solution might be implementing a retirement plan and paying yourself by funding your retirement plan, which can allow for a nice tax deduction,” Pravett said.
Ultimately, every business has a unique set of circumstances. These circumstances require special attention when it comes to determining owner compensation.
Why Should Small-Business Owners Pay Themselves?
Pravett said the saying “the cobbler’s children have no shoes” comes to mind when considering business compensation.
“A business can’t operate without the original owner’s involvement and drive, but the business owner is often the last person to get paid,” Pravett said.
If the cobbler is too concerned about their business and clients, so is the business owner with their clients, employees and company as they neglect to pay themselves a salary. Once business owners consider their own compensation needs, an entire world of opportunities opens up to them. Business owners can put themselves on the payroll and start establishing retirement plan options and company benefits for employees.
“A business owner needs to start considering a compensation plan sooner rather than later to establish a healthy company that can not only sustain the owner’s lifestyle but allows that owner to enjoy a return on their investment,” Pravett said.
More From GOBankingRates
- The 15 Biggest Bank Failures in US History
- Financial Insight in Your Inbox: Sign Up for GBR's Daily Newsletter
- Maximize your savings with these 3 expert tips
- Take Our Poll: How Do You File Your Taxes?
