Anyone who has not owned a business might romanticize the idea of “being an entrepreneur.” It is simple to envision charismatic CEOs who have everything under control and take hefty salaries home. However, if you have been a business owner, you understand the reality is quite the opposite. A business owner’s life is seldom that uncomplicated, particularly when it comes to a small business owner’s wage.
Small business owners and business owners, particularly those who are just commencing, can often find it difficult to determine exactly how much they should be compensating themselves. It is not a simple task. Most do not wish to withdraw any money from the business when it is still not entirely established. On the other hand, they require funds to meet personal expenses, and frequently their business is their sole source of income due to having invested everything in it.
The median business owner salary in the USA is somewhere between $68,000 and $72,000. It is significantly higher than the average income in numerous industries, but many business owners do not remunerate themselves. If you have established your own business but are undecided about your salary, this article is for you.
What’s the Median Business Owner Salary?
If you are contemplating how much to compensate yourself as a business owner, you might be pondering what others in your position earn. Although many small business owners do not take any salary, that does not mean you should forgo a business owner salary for yourself. An American Express study found that the median business owner salary is only $68,000, somewhat down from the previous year. According to Payscale, that figure is nearer to $72,000.
In any case, it is apparent that most small business owners do it out of passion, not because they are aiming to get affluent quickly. Anyone who has been a business owner understands it entails hard work, often extending into late nights and weekends. The good news is that as you progress, you can expect your business owner salary to increase as well.
Why Should You Provide Yourself with a Salary as a Business Owner?
The primary reason business owners should give themselves a fixed salary is to control the amount of money withdrawn from the business capital. If you do not define a set amount as your salary, you will not manage your business expenses as effectively.
Moreover, once you pay yourself a fixed salary as a business owner, you will be further motivated to run the business smoothly while maintaining self-appreciation. Such concrete factors are excellent motivators for small business owners.
Evaluating Your Business Owner Salary
All the prominent tech CEOs in the United States receive a dollar as profit. Do not romanticize that notion. You do not possess billions in stock options to cash in, and your company is not flush with cash to cover your business expenses, at least not yet, so take a fairer approach. You will need to contemplate carefully to arrive at a figure that you consider suitable for you and does not adversely impact the business’s growth.
If you do decide to compensate yourself, then how much should it be? As much as the business can afford or just enough for you to live on? Unfortunately, there is no hard and fast rule for determining a suitable business owner salary. However, there are some factors that you can consider that will help you land on a reasonable figure.
Reasonable Compensation:
Ultimately, there is no magic formula or small business owner salary calculator to accurately determine how much to compensate yourself. It is an incredibly business-specific question that depends on numerous practical and personal factors.
To arrive at the correct figure, go through this checklist:
- Comparable Salary
If you were employed by someone else to perform the role you are currently undertaking, what would your salary be?
Analyze hourly or yearly industry market value through your industry’s trade association, the SBA’s Income Statistics page, or a salary listing on sites including Glassdoor, Salary.com, or Payscale.
That being said, estimating your market value can be complex if—like many small business owners. Therefore, if obtaining a matching job description is unsuccessful, consider an alternate approach. List the most common responsibilities you undertake, then determine the cost to outsource those tasks to someone else.
This combined number is sometimes referred to as your “true wage.”
- The Tax Factor
Depending on your business’s entity type and whether you are receiving a salary or draws, there are tax advantages and disadvantages to taking a payout versus reinvesting in your company. Make sure you have familiarized yourself with these pros and cons and plan ahead.
Consult with a competent accountant—ideally your business’s own, but a certified public accountant is also acceptable—to determine precisely which tax regulations affect your company and how. An accountant can also help you identify ways to maximize deductions, shareholder distributions, and other tax breaks that will aid you in determining the funds to compensate yourself a business owner salary.
Conversely, reinvesting some funds back into the company (rather than taking them as remuneration) is another way to minimize tax obligations. Moreover, down the line, lenders will want to see that you have invested in your business—especially if you are applying for a highly sought-after SBA loan.
Tax Implications
There are also tax implications for withdrawing a business owner’s salary compared with reinvesting the money into your business. As these are intricate and vary by business structure, it is best to seek the assistance of a qualified finance professional. You may discover that the tax implications dictate your salary for you, since the rates increase at specific thresholds.
This is a crucial factor that some small business owners may overlook when commencing. You will be required to pay taxes on the money that you compensate yourself; it is treated as personal income, so make sure that you maintain all documentation and pay the due taxes promptly.
You also need to be mindful of maintaining a consistent payout schedule. Random draws from the company could lead to an IRS audit on your business. This not only impacts your business’s cash flow but is also an additional distraction that you can certainly do without.
This might be a lot to figure out on your own. The best approach here is to heed the advice of a qualified tax professional. They will be able to help you ensure that you are fully compliant with the tax responsibilities. IRS fines are no joke, and it is always better to invest in a professional rather than paying substantially more in fines if discrepancies are found during an audit.
Establish a Salary as a Percentage of Profits
You will need the assistance of a business analyst or someone similar to provide you with a fairly accurate business forecast. This will enable you to view business growth projections, including revenue projections for the years ahead. Once you have the figures, such as your projected business costs, taxes, growth plans, expansion, and/or merger costs, you can start to set a baseline for your salary. Most small businesses limit their salary percentage to 50 percent of profits.
If your business is yet to surpass the start-up stage, you simply need to analyze your personal costs and a few small business overheads to arrive at a figure for your salary.
Cash Flow
Cash flow is a crucial factor for any business, so it is essential to consider how withdrawing a salary will impact it. Are you generating a consistent income that enables you to compensate yourself a salary? Do your customers make timely payments, and would you still be able to pay yourself if an invoice becomes overdue? Base your figures on the worst-case and best-case scenarios so that you will not be caught off guard in a quiet month.
Remember, ensuring the smooth flow of business is of paramount importance. Avoid putting yourself in a position where you have to shut down your company due to cash flow issues. This will serve as a warning to any potential investors, even for your future endeavors, as it indicates mismanagement.
They would not be pleased to learn that a business owner paid themselves excessively and ran out of funds to pay their employees, leading to a shutdown. Ensure no mistakes are made when you have determined your salary and project how compensating yourself would reflect on the business’s balance sheet.
Salary or Owner’s Draw Method
There are two primary approaches to compensating yourself a business owner salary—with a regular salary or through owner’s draws.
1. Salary Method
The salary method is essentially akin to being remunerated in the broader workforce. You are paid on a regular schedule, either based on hours worked or at a flat rate.
In fact, if you are an officer of a C-corporation or the owner of an S-Corporation, you are legally obligated to receive a regular salary with withholdings for Social Security, Medicare, and federal and state income taxes.
2. Owner’s Draw Method
An owner’s draw is a withdrawal from your company’s profits—profits, not revenues—payable to you, the owner. Ensure that you account for all expenses (rent, utilities, employee salaries and benefits, supplies, equipment needs, and all the rest) when determining how much you can safely afford to take out of your business for your own pocket and when.
This means you need to be intimately familiar with your company’s profit and loss statements before making this decision.
Draws are not subject to withholding for Medicare, Social Security, or income tax when they are disbursed—but remember that you will still have to report that income and pay equivalent taxes on it at the end of the year. If you take draws, keep meticulous records and consistently set aside money for taxes so you are not caught off guard on Tax Day. Your small business accounting software can also automate this process for you.
Sole proprietors, partners, and owners of LLCs are not subject to the same rules as corporations. What is left after deducting expenses on Form 1040, Schedule C (for sole proprietorships) or Form 1065 (for partnerships) is considered profit by the IRS and viewed as the owner’s personal income.
Essentially, these business owners are self-employed; as such, they can compensate themselves however they prefer, be it through draws or salary. S-corp owners can also take a draw in addition to their salary.
Final Thoughts
The salary of a business owner is entirely contingent upon the growth potential of the business. If you are confident in the said enterprise’s growth, you are better off reinvesting in the business and weathering a slow market period to emerge as a market leader within your business’s sphere of influence.
If you intend to grow it solely to sustain a limited business size without much expansion, it would be advisable to gradually give yourself increments in pay to maintain your financial stability personally.
