There’s very little that’s easy about starting a business, and one of the hardest decisions to make can involve deciding what your salary should be.
Not always, of course. If you’re starting a business with a lot of revenue coming in right away, and money isn’t an issue, you can probably land on a salary number pretty quickly. For instance, if you’re buying a franchise or purchasing an existing business that already has employees and customers, things will probably look pretty clear once you talk things over with an accountant or financial advisor and if you know what is a conventional salary for a business owner in your industry.
And if you’re starting a business with no savings, and you’re unsure if you’ll even have customers, you’re probably going to wing it and take whatever revenue you can for yourself — and put anything else left over into your business.
There’s no one right or wrong way to go about deciding what your salary should be. Still, because of tax considerations, and if you want your business to grow and thrive as much as possible, you should consider several factors as you try to calculate an appropriate salary.
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How you structure your company matters. If you’re a sole proprietor, you’re the only owner of the business. Which means that you don’t need to register your business with your state. You just start it up and watch the money roll in, or, um, not. In other words, your salary can be whatever you want it to be. But there are plenty of reasons to not have a sole proprietorship and instead structure your business as an S corporation, LLC or corporation. For instance, if someone sues your business, as a sole proprietor, they’re also suing you — so your home, your assets and everything you’ve worked for could potentially be in danger.
Now, if you structure your business as something other than a sole proprietorship, what you are allowed to take as a salary gets more complicated, if you want to stay in the good graces of the Internal Revenue Service. For instance, you might, with an S-corp, receive a salary and dividend payments. Really, you should talk to a tax accountant about all of this no matter what you decide but especially if you plan on going any route other than as a sole proprietor — unless you’re starting a new tax accountancy firm, in which case, hey, you can talk to yourself.
Consider the one-third rule. If you’re starting a sole proprietorship and you don’t have employees yet, setting a salary for yourself may seem pretty straightforward: Take whatever money comes in, and put it all in your bank account.
But Chris Wolpert cautions against that. After all, you want your business to grow and thrive right? Wolpert says that his insurance agency, Group Benefit Solutions, which opened up for business last year in Tacoma, Washington, operates under a one-third rule.
“The first one-third of my business gross income goes directly into a money market account, mostly for taxes but also to build a reserve. The second one-third goes toward my business expenses, like software, vendors, marketing and conferences, and the third one-third is anything available for me to take personally,” Wolpert says.
He adds: “It seems rigid, but it actually allows a lot of flexibility, and I’ve never once had to worry about cash flow.”
Of course, your success with your salary and cash flow all depends on the business. If you have an insurance agency, you’re probably making more revenue than someone who owns an online thrift store.
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Don’t shortchange your business — or yourself. You’ve heard of escape rooms, where you and friends or family are locked in a room, and you’re given clues you have to solve in order to break out? In 2013, Nate Martin and Lindsay Morse co-founded Puzzle Break in Seattle. They now also have escape rooms in Long Island, New York, and Newton, Massachusetts.
Martin says when he and Morse started their business, they were very careful to hit the right mark with what salary they took for themselves and what they gave back to Puzzle Break.
“My co-founder and I opted to pay ourselves enough to be comfortable but no more and invested the rest into the business,” Martin says.
Their reasoning?
“Anything more would impact the business,” Martin says. “Anything less would be detrimental to our quality of life, which would impact the business.”
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Professionals can help steer you away from potential pitfalls. Seek guidance from a certified public accountant or a tax advisor, who can tell you if you’re paying yourself too much or too little, or why you should or shouldn’t structure your business as a sole proprietorship or an S-corp. Still, as you do noodle over numbers, whether on your own or with a professional, your calculations “should be based not only an anticipated net profit but also on how much after-tax income you need to fund your personal life,” says James O’Sullivan, a business planning attorney with Tiffany & Bosco, P.A., based out of Phoenix.
He also adds a warning to overly enthusiastic novice business owners, who think they can start a business with next to nothing and not take much of a salary. O’Sullivan says that in over 30 years of practicing law, the No. 1 reason entrepreneurs get divorced is due to underestimating what they need to maintain a reasonable quality of life.
Which is at least part of why O’Sullivan feels so strongly that it’s important to seek the advice of a professional when deciding what your salary should be.
“CPAs and other skilled business and insurance consultants can be invaluable in helping to build — and poke holes — in both personal and business budgets,” O’Sullivan says. “Spend a bit more money with these professionals. and many entrepreneurs will spend a whole lot less on business lawyers like me.”
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You’re Starting a Company. What Should You Pay Yourself? originally appeared on usnews.com
