As an entrepreneur, you’re the last person who has to be reminded that owning a small business almost never means swimming in cash. In fact, sometimes it barely means consistent returns. Some business owners reinvest every penny they earn right back into their business, and, as a result, don’t take an entrepreneur salary. It’s a great gesture—but you might be selling yourself short in more ways than one.
Here’s why you should be taking a salary as a small business owner, and a couple of methods to choose from when deciding how to pay yourself. Just like there’s no single formula for running a business, there’s no hard-and-fast rule about paying yourself. But there’s a good theory behind why you’ll want to compensate yourself for your ‘round-the-clock work.
Why You Should Pay Yourself a Salary as a Business Owner
You might be sheepish to take a salary because you feel like you’re almost stealing from your business. If you could be growing your company, you shouldn’t be spending that money on yourself, right? No!
You work, and you should be compensated for your time. It’s unfair for you as an employee (even if you’re your own boss) to not be able to pay for your personal expenses. Plus, run correctly, your business should have a healthy enough cash flow to be able to sustain a payout—even if it’s small. If this isn’t the case, it’s time to take a hard look at your cash flow and narrow in on ways to improve it.
Psychologically, it’s important, too. You want to keep yourself motivated personally. There are a lot of reasons why taking even a small paycheck can help your business all around.
The Two Types of Entrepreneur Salaries
There two main types of methods by which you can pay yourself as a business owner. Depending on the setup of your business, and your level of comfort for paying yourself consistently, you should be able to identify which of the two methods feels right for you.
Salary Method
The “salary method” is pretty much what is sounds like. You’ll pay yourself a fixed salary, just like you would if you were an employee of another company. You’ll have to make sure you’re removing the same withholdings (such as a taxes and entitlements) as you would for anyone who works for you. If you own a corporation and are involved in the operations, the IRS will expect you to take a salary, not an owner’s draw.
Draw Method
The “owner’s draw method” is more like working on commission. The difference here is that you’d take a percentage—or draw—of your company’s profits after you’ve deducted all of your expenses and taxes from your earnings. What’s exciting about this method is that if you have a gangbusters season, you can do brilliantly well; and, since this is calculated after taxes, this amount isn’t subject to tax. If you own an LLC, sole prop or a partnership, the IRS considers you self-employed and therefore you’re not required to take a regular wage.
Whichever method you choose, make sure you calculate what’s considered your “reasonable compensation” as determined by the IRS—in other words, what another employee in your role would get. A site like Glassdoor can help you figure it out. That way you won’t raise any tax red flags. You’ll also want to establish a consistent payday for accounting purposes, but also to keep things consistent for the IRS to avoid an audit.
Keep Your Finances Separate
As you start to pay yourself an entrepreneur’s salary, you absolutely must make certain that you have your personal and business finances separate. You’ve likely heard this before, especially if you’re in early stages. But there’s no delaying this decision now. You can’t pay yourself a salary and have clean, clear business taxes without a separate business and personal bank account. If you have commingled finances, separate your business and personal finances ASAP.
Paying Yourself As a Small Business Owner
It’s a struggle to understand if you should pay yourself, and how much you should pay yourself. But understand there’s something of a method to the owner’s salary madness. Plus, researching other business owners in similar positions can help you feel like you’re not totally shooting in the dark.
Remember that no decision you make is permanent and you can always change your method and your number. If you need to, reach out to your accountant to see what your business can handle on the cash flow and profit and loss side of things to get a good sense of your numbers, too.
