How much should I pay myself? That's a question asked frequently by many small business owners we talk to.
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Believe it or not, many small business owners struggle with deciding how much to pay themselves -- and for good reason.
On the one hand, you need to withdraw resources from the company to provide for your family and living expenses, even though you already own all the company's assets. On the other hand, you need to weigh the amount of resources you withdraw against the needs of the business – long-term viability, employee morale, and tax deductibility of compensation expenses.
Determining how much to compensate yourself will depend on a variety of factors ranging from the business' stage of life to your own personal needs. Here are some of the options that are available to you:
Some business owners decide not to compensate themselves at all, especially during the startup period. Rather than drawing a salary, their reward comes in the form of business growth. As the business grows the value of their investment (the business) increases. While zero compensation is common among startups, business owners rarely refuse compensation once the business has gotten on its feet.
Deferred compensation is another popular form of compensation for startup businesses. Rather than draw a salary from the company during the critical startup phase, the owner chooses to defer his/her compensation until the business is more established.
The key to deferred compensation is documentation. You cannot retroactively decide to pay yourself a deferred compensation package if you want to take that compensation as a deduction on your taxes. However, if you document the amount of deferred compensation in advance, the IRS is more likely to accept an extraordinarily high salary deduction that includes a deferred compensation component.
Hire family members
Some small business owners have chosen to augment their own salary by employing family members in the business. This is not the type of arrangement that exists only on paper. The family members actually have to do the work. However, by employing a spouse or child, the financial gain stays in the family and the business can deduct it as a legitimate expense.
At any time, owners are free to pay themselves a dividend from the business. Although this can be for any amount, you need to be careful not to withdraw so much as to cripple your company's ability to do business. Likewise, you need to be sensitive to your employees. The week you layoff a quarter of your staff is probably not the right time to take a $150,000 dividend out of the business.
Another form of deductible compensation is fringe benefits. In many cases, the IRS allows business owners to deduct expenses such as travel and company cars provided they are used for business purposes. In some cases, you may also have to provide similar benefits to other employees. Check with your tax preparer to determine which benefits meet IRS qualifications.