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Small Business Owners: Are You Paying Yourself Enough?

“Don’t forget to look out for No. 1.” That’s some of the best advice a small business owner can take … but it’s also the advice that many entrepreneurs ignore.

They do so at their own peril.

Most small business owners don’t have a lot of wiggle room when it comes to the company’s finances. It can be difficult to even keep the lights on, order office supplies and pay your employees, not to mention find enough extra money to put toward growth. As a result, many owners make too large a sacrifice, paying themselves less than what they should just to make the numbers work.

On its face, it makes sense to take one for the team. But paying yourself too little (or worse, failing to pay yourself at all) can have a negative impact on you, as well as the small business you’re trying to keep afloat.

Here’s why it’s important to pay yourself enough, and how to figure out how much you should make.

Why You Should Pay Yourself

There are two main reasons to properly and fully paying yourself – one is practical, and one is a little less tangible.

The practical reason is: You have to eat. If that sounds simple, it’s because it is. As a human being, you have basic needs such as a roof over your head, food in your belly and money to see a doctor if you get sick. You can’t properly run a small business if even your most basic needs aren’t being met. That’s why it’s vital to make sure you have pay, healthcare, retirement benefits – everything you would receive as an employee at another company.

Beyond that, countless hours of research have shown pay is also highly tethered to morale – and that includes owners. Proper pay instills a sense of self-worth, and also can act as motivation to keep pushing yourself to be better.

How to Pay Yourself

As a small business owner, you actually have several options at your disposal, and they hinge on what type of business entity you operate – say, a sole proprietorship, limited liability corporation or a corporation.

The most common choice for business owners is to simply become a W-2 employee. It’s the typical relationship you come across as an employee of other companies, and it’s an option as long as you make at least $600 annually.

A few other options include an owner’s draw, typically the realm of sole proprietors and partnerships; dividends (a return of capital) from the company; and even shareholder loans, though this latter payment option potentially can fall under one of several types of tax treatment.

How Much Should You Make?

This is the tricky part. There is no perfect, easy formula to get there, especially because so many numbers vary depending on geographical location and industry. But here are the things you should consider to get to that magic number:

  • The Basics: Calculate how much you need for housing, utilities, food, gas, etc. – the things you need to live. This also should include any debt payments you currently make, such as student loans or credit card debt, as you don’t want to default just to keep your small business alive. And while it’s easy to remember monthly expenses, think about the whole year – annual doctor’s appointments, occasional medication, etc.
  • The Field: You also should get an idea of how much you’re worth based on the going market rates for people in your industry. For instance, let’s say you’re already an employee but are starting your own small business in the same field. You likely are worth not just what you were paid, but also an additional amount because of all the new responsibilities you are taking on. For instance, a baker starting a bakery with no other employees is also the CEO, accountant … you get the picture.
  • Taxation: Taxes are one of the least interesting parts about planning a small business, so it’s easy to overlook tax considerations when determining how you get paid. But the right tax strategy can make a difference of thousands of dollars, so take tax-efficiency into consideration when deciding how you will get paid. For instance, while merely taking a salary might seem like the simplest option, you can generate tax savings by weaving in dividends, stock options and even bonuses.

If that seems like a lot to consider … it is. Being an employee means filling out a couple forms and taking what ownership will give you. What small business owners pay themselves is more complicated because they have more options.

McManamon & Co. offers a wide range of business consulting services, which includes helping you make the best decision about how to pay yourself.  Whatever you do, don’t shortchange yourself. Your hard work deserves more reward than merely virtue. Call us at 440.892.9088 or contact us online for all of your small business payroll questions.

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