5 questions to ask when deciding how much to pay yourself

April 6, 2017

This post is part of our “5 questions” series, helping merchants ask the right questions before making key business decisions. Read the entire series here on the Clover blog, and explore for more better business tips and tactics.

You’ve finally gotten your business to a place where it’s stable enough, maybe even profitable enough, that instead of throwing money into it to keep it running, you’re actually going to be able to take money out. Congratulations! It’s a huge step forward.

But deciding what to pay yourself as a business owner is, in many ways, even trickier than deciding what to pay your employees. With an employee, you’re going by the market rate in your area—whatever it takes to attract and retain the talent you need. But when it comes to paying yourself, you’re balancing your own income needs against the needs of your business. Here are five questions to ask when deciding how much to pay yourself:

1. How much do you need to live on?

Burnout is a serious risk for entrepreneurs, and if you’re working crazy hours and struggling to support yourself, you’re only going to burn out faster. If you want to stick with your business for the long haul, you need to pay yourself a salary that’s sustainable. Be sure to build in the ability to take modest vacations and save for retirement. Both are crucial parts of building a lifestyle that you can sustain for the years it’s going to take to achieve your goals.

2. How much can your business afford to pay you?

Of course, there’s what you need and there’s what the business can afford. Maybe your salary needs to start small, and you can plan on giving yourself a raise as you hit certain growth targets. Make sure you don’t over- or underestimate what’s possible based on one good or bad year. If you’ve been operating for several years, look at your average revenue to calculate a reasonable salary that the business can sustain through market fluctuations. If you’re a newer business, talk to other business owners in your area or a mentor from an organization like SCORE to figure out what you can expect as your local economy expands or contracts.

3. What are your long-term goals for the business?

It may be tempting to maximize your payout now that your business has the cash to throw around, but if you’re aiming for significant growth in the next couple of years, you’ll want to save some of that cash to hire more employees, buy or rent more equipment, or whatever else you’re going to need to meet your goals. On the other hand, if you’re hoping to cash out or retire soon, then you’ll want to talk to an accountant about what makes sense from a tax perspective—earning more now, or later.

4. Can you take a draw on top of your salary?

Depending on how your business is structured, you may be able to take what’s known as a draw or distribution from the profits on top of your salary. On the plus side, you don’t have to withhold payroll taxes from a draw. But a draw could also set you up for greater scrutiny from the IRS, so be sure that you don’t artificially deflate your salary to inflate that draw.

5. What’s reasonable for your industry?

If your company is structured as a corporation, and you’re an officer of that corporation, the IRS requires that you get “reasonable compensation” for your work. If they find you’re underpaid, you and your business could be in trouble. Do some research to figure out what you might earn as an employee of another company in your area so you know you’re in line with what’s “reasonable.”

[image: Numbers and Finance by Ken Teegardin on flickr]

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