How to Calculate a Business Owner’s Salary
As a business owner, thinking about paying your employees or investing appropriately in your business can become second nature. However, paying yourself is just as important.
There are a few ways a business owner can pay themselves while accounting for business debt and taxes. Here’s how to calculate your salary and determine when and how you pay yourself.
ways to pay yourself
Here are two common ways small business owners can pay themselves in their business:
- Salary: With the salary option, you pay yourself the same as your employees – including withholding taxes. Use similar jobs in your field as a guide when calculating your salary. Keep in mind that the IRS compares your salary to others in similar fields to make sure it’s “reasonable.” This rule is typical of business owners (S-Corps and C-Corps) who are taxed on both their personal income from the business and their reported profits.
- ownership: An ownership move means that you transfer money from your company’s profits to yourself as needed. Although you don’t have to pay taxes up front for every draw, for self-employed people, you do have to pay taxes either quarterly or annually when you file your tax return. This payment arrangement is typical for owners of pass-through entities such as sole proprietors, partnerships and most limited liability companies (LLCs).
Tips for setting your compensation
Calculate your net income
Calculating your net income ensures your business can cover expenses before you calculate your own salary. This step is crucial to avoid debt or even bankruptcy. First, subtract the cost of your business expenses (eg, employee salaries, rent for your office space, etc.) from your gross income to find your net income. Once you deduct the taxes to be set aside, subtract your salary from that number.
Think tax savings
Planning (and saving) throughout the year is necessary to keep tax payments from adding up. According to the IRS, most corporations and independent business owners that make more than $1,000 in annual tax payments are required to file and pay estimated quarterly taxes. Whether you’re a new or existing business owner, consult with an accountant to determine the tax specifications your business requires and avoid penalties.
Tax calculations should always be done before any expenses are deducted. A good rule of thumb is to save 30% of your income for taxes. This percentage may be higher if you or your joint filing partner are in a higher tax bracket.
[Read more: The Most Common Business Entities for Startups]
Planning (and saving) throughout the year is necessary to keep tax payments from adding up.
Consider your business debt
After accounting for tax payments, you can use these funds to pay off your company’s debts. If you have borrowed money or used a credit card, your lender most likely requires a minimum payment each month. Subtract that entire minimum debt payment from your net monthly income. If you have extra funds left over after paying yourself, you can increase your monthly payments and pay off your debt faster.
Create a business savings plan
Build a savings buffer while you have the cash for new hires, training programs, or emergency funds. Find out which goals are most important to you and which ones you can put on hold. Your future self will appreciate the effort you make to set aside funds for your business goals and break them down into monthly savings.
How much should you pay yourself?
After deducting all of the above allocations, you can start calculating your own salary. The remaining number counts as your annual salary. You can divide that by 12 for your monthly salary or by 52 for your weekly salary. Also, divide your weekly salary by the number of hours you work to find your hourly wage.
U.S. small business owners make about $70,000 on average, but many don’t receive a salary in their early years. On the other hand, some business owners may overpay and limit their business growth. You should pay yourself enough to live on, but be realistic about what you need to live on and what might be overkill.
[Read more: How to Do A Competitive Salary Analysis]
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your unique situation.
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Released October 17, 2022