The “rule of thumb” for paying yourself as a business owner is not one-size-fits-all, as it depends on various factors, including your business’s financial situation, your personal financial needs, and your long-term goals.
Here are some general guidelines and considerations that can help you determine appropriate compensation for yourself:
- Cover Your Living Expenses: Your primary goal should be to pay yourself a salary that covers your basic living expenses, including housing, utilities, groceries, transportation, insurance, and other essential costs. This ensures that you can maintain your standard of living while running your business.
- Consider Business Profitability: Pay yourself a salary that your business can afford without negatively impacting its financial health. Assess your business’s profitability, available cash flow, and your ability to cover your compensation from business revenues.
- Balance Business Growth: If your business is in a growth phase, you may choose to reinvest more of the profits back into the company rather than taking a high salary. This approach can help fund expansion and increase your business’s long-term profitability.
- Account for Taxes: Consider the tax implications of your salary. Paying yourself a reasonable salary can help you manage your personal tax obligations, especially if your business is structured as an S Corporation or an LLC that has elected to be treated as an S Corporation. If you’re not paying yourself a reasonable salary, the IRS may reclassify distributions as wages, potentially leading to additional payroll taxes.
- Consult with Financial Professionals: It’s advisable to consult with a financial advisor or accountant who specializes in small business finances. They can provide personalized guidance based on your specific business’s financial situation and your personal financial needs.
- Regularly Review and Adjust: Periodically review your salary to ensure it aligns with your business’s performance and your personal financial needs. Adjust your salary as necessary, based on changes in your business and personal circumstances.
- Consider Personal Savings and Retirement: In addition to covering your living expenses, ensure that your salary allows you to save for personal goals, emergencies, and retirement. Consistently contributing to personal savings and retirement accounts is essential for long-term financial security.
- Understand Your Industry: Research industry standards and salary data for positions similar to yours within your business. This can provide a benchmark for what others in your industry and role earn.
- Tax-Efficient Compensation: Consider the tax-efficiency of your compensation structure, including the mix of salary, dividends, and other forms of income. This may vary depending on your business’s legal structure.
- Personal and Business Goals: Your personal and business goals should guide your compensation decisions. Balancing your short-term financial needs with long-term financial security and business growth is key.
Remember that the appropriate salary for a business owner can evolve over time as your business grows or faces economic changes. It’s essential to manage your business’s finances responsibly to ensure its long-term success while also meeting your personal financial goals. Consulting with financial professionals and regularly reviewing your financial situation can help you make informed decisions.