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What to Pay Yourself

It's your business. You get paid what you want, right? Not quite. Here's what you need to take into consideration before setting your salary.

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There is no place where self-discipline plays a more important role than in setting your own salary. As the owner and founder, you can allocate as much or as little of the company's profits as you want to your own paycheck. You can even decide to go further. You can tell your accountant to cut you a check equal to the entire month's sales. That will be a high-water mark for your earnings, however, since draining that much cash will ensure that it is your last month in business.

There are two groups of interested parties in the decision about how much to pay yourself. First, you have to do right by your partners (if any), employees, suppliers, creditors and customers. If you take money out your company for yourself to the extent that any of these parties are damaged, it could be a mistake.

But you also have to consider yourself (and perhaps your spouse and your children), as well as any charitable causes you support out of your earnings. These interested parties deserve a fair cut of the bounty, too. You should get a decent return on the labor and risk you have invested. Your family should, of course, share in those benefits.

Complicating the issue is the fact that there is no set amount an entrepreneur should earn. Strictly speaking, it's all yours, or as much of it as you retain ownership of. Of course, a board of directors, partners, other owners and lenders may also have a say in this. Absent all limits, in a world where only you and your company are involved in the decision, you have to choose between taking money out to spend on yourself and your interests outside work, or reinvesting it in the company, where it can power further growth. The decision to take or reinvest profits is a highly personal one that turns on the fulcrum where your interests and those of your business coincide.

Other than taking a salary, there are several ways you can get value out of your business. They are:

  • Dividends. You can elect to pay yourself any amount you want by declaring it a dividend.
  • Paying family members. You can hire family members and pay them just like regular employees (as long as they're working just like regular employees.) This at least keeps the money in the family.
  • Fringe benefits. You may be able to pay for country club memberships, company cars, luxury business trips to popular destinations, and give yourself other attractive perquisites-and have them treated as tax-deductible business expenses. Just make sure you offer them to other employees as well.
  • Delayed compensation. If you chose to forgo compensation during your start-up phase, when cash was critical, you can take larger compensation now without fear of being accused by the IRS of taking excessive compensation-as long as you carefully documented your delayed-compensation plan when you were carrying it out.
  • Don't forget loans. You may be able to take a loan from your business as long as you document it in writing, pay a market rate of interest, and have a definite schedule for repaying it. Without those features, a loan between a business and its owner may run afoul of the IRS.

One more note: Be careful about paying yourself a very high salary and attempting to deduct it as a payroll expense. The IRS tends to view such salaries as dividends, which could mean you can't deduct your compensation as a business expense. Plus, you'd have to pay corporate taxes on the dividend.

Excerpted from Growing Your Business