Should Business Owners Take a Salary? Consider the Pros and Cons
Running a business requires a strong sense of responsibility, focus, and authority. When it comes to their compensation, they have different methods of payment to choose from, each harboring its own set of challenges and rewards.
Many entrepreneurs find themselves questioning the right form of self-compensation. Should you put yourself on your company’s payroll over distributions? Most business owners, especially those who run smaller enterprises, often compensate themselves using a draw.
With that in mind, is taking a salary the right move for the modern entrepreneur? There are some upsides, however, not without a few drawbacks in the mix.
If you’re looking for some clarity on the subject, take some time to navigate the pros and cons of taking a salary from your own business.
With a salary, you’re paying yourself just as you would an employee of your company. Earning a salary is a familiar process with notable highlights of its own.
Explore the relevant pros of paying yourself a regular salary.
A Steady Income
Taking a salary from your enterprise is a stable option, and stability is a superpower in the world of business. You’ll earn a consistent paycheck that acts as a recurring expense you can budget into your company’s costs.
Sounds like a win-win.
A Better Work Environment
It’s no secret that a business is fueled by its team of exceptional employees. When you’re taking home a profit as a business owner, you’re naturally motivating employees to work harder.
That’s because they’re likely to take an interest in a share of the profits, which contributes to their work ethic. Motivated employees can improve your company’s performance, and taking a salary plays a pivotal role in this scenario.
Taxes are Deducted Upfront
How you pay yourself is solely determined by the kind of business you’re operating. Keep in mind, you’re not authorized to be on the payroll in some situations.
Yes, you can pay yourself from the company’s profits, however, those earnings aren’t tax-deductible. It’s advisable that you take distributions and make projected tax payments.
Quick tip: In sole proprietorships and partnerships, you’re expected to pay self-employment tax on your business’ total profit every year.
This accounts to nearly 15% of your net profits, so be sure to pay your taxes on time to steer clear of a whopping tax bill – it’s not the best way to end the year.
While taking a salary from your business can be extremely beneficial to its internal operations, there are a few downsides to this payment system.
Depending on the type of business you own, taking a salary could negatively impact your company. Examine the cons of paying yourself a salary.
Uncertainty of Pay
Taking a salary out of your own business comes with an inescapable challenge: figuring out how much you should pay yourself. Data presented by Payscale showed that the average business owner makes around $70,220 per year.
However, in the first few years, many entrepreneurs don’t take home a salary. Here are some things to consider when estimating your potential revenue:
- Business Performance: As a business owner, remember that your compensation isn’t set in stone – it’s still possible to make some changes as you observe your company’s performance. In reality, you should only take a cut from your profits, not the overall revenue. If your business is performing exceedingly well, you may be able to increase the amount of money you take home.
- Business Growth: The current state of your business in an important thing to keep in mind when determining your salary. Suppose your company is a newer startup that’s experiencing positive growth – there’s a good chance you’ll want to reinvest most of the profits back into your business, as opposed to pocketing them.
- Personal Expenses: Get an idea of what your most frequent expenses are. Besides your mortgage or rent, be sure to take into account other personal expenses that require funding.
You’ll need to decide how often you want to pay yourself. Business owners usually choose to be paid biweekly. To stay on top of your taxes, pay yourself quarterly at minimum.
If Your Business Slows Down, your Pay will Suffer
Let’s say you chose to stick to a consistent payment, and your business suffers a bad month. Your numbers have taken a hit, and your salary cannot change.
You have to follow the reasonable compensation rule, regardless of your company’s performance that month. This is likely for smaller businesses that produce inconsistent sales. Not only is it frustrating, but it could also hurt your company.
Income and Payroll Taxes
A salary is often deemed more complicated because you have to withhold income and payroll taxes. Furthermore, business owners taking a salary impacts their personal tax liability.
How Much Income Should You Take from Your Business?
While taking a portion of your business’ income doesn’t have a legal limit in most countries, there’s certainly a limit in terms of maintaining the functionality of your business.
If you are taking invested operational capital and cashflow from your company’s revenue, then it will eventually run out of funding. With that said, avoid withdrawing more than 100% of profits.
Be sure to pay all the expenses and debt repayment before you invest half of the profits into your company. Determine a salary and add yourself to your company’s payroll. Every expense, your salary included, will profit back into your business.
Then, take home the remaining half of these profits as your share.
The Key Takeaways
Yes, you can handle payroll processing on your own, however, you may prefer using a payroll service that sends payments to taxing authorities, generates pay stubs, and calculates taxes for you.
As soon as you start paying yourself, be sure to adopt a schedule and remain consistent. Keep a close eye on things throughout the year in case any changes need to be made for the better of your company.
It’s an intricate process, but it’s entirely possible with the right tools. Keep in mind the pros and cons of taking a salary as you come to a final decision.