New business owners often ask me, “What should my compensation be? How should I pay myself?” Here’s what I like to tell them.

One classic mistake new business owners make is to undervalue themselves. Undervaluing yourself lowers productivity, and creates stress. Your business plan, must include a salary for you and a plan to fund that BEFORE you are making a profit. It can take several years for a business to turn a profit, which you use to pay yourself—planning for that period will alleviate some of these considerations.

How to Determine Your Compensation?

Start by doing your research. Compensation needs to be reasonable and related to how much the business is earning and how much is going out for expenses. 

• Look at similar businesses that pay for the work you do.
• Talk to owners of similar companies.
• Look up industry pay levels. There are several online.
• Learn about the different ways you can pay yourself as an owner.
• Join supportive Facebook and LinkedIn groups in your field.

A CPA is your best friend when you start a new business. Discuss your compensation plans and ask for recommendations. Your accountant will help you decide between a salary or an owner draw.

Equity 

Equity is the value of the company after deducting liabilities. When you invest funds in equipment, or other assets in the company, you are increasing the equity. A company loss, expenses are higher than gross profit, will result in lowering the equity. An owner’s draw will also decrease company equity.

Owner Draw

As an owner, when you take money out of the company account for personal use, it is referred to as a draw. In the early life of a business, draws are often easier for flexibility and cash flow reasons. Draws do not have deductions, so you will be responsible for declaring draw amounts as income when you file your income taxes.  

Salary 

Your salary is a set wage or amount of compensation for every pay period. 

Payroll taxes are deducted from your paycheck and paid directly to the IRS on a regular schedule. A salary offers you a stable and predictable compensation. The difficulty with salary for a new business will be cash flow. If you have an off month or your customers do, you can modify your check. 

The IRS has guidelines for what they consider “reasonable compensation.” A company issuing a paycheck has payroll expense obligations for matching funds to Social Security and Medicare. As the company grows and you take on employees and offer benefits, these will also become company payroll expenses.

Tax Classifications

It’s important to know your tax classification and how it affects your business. In short, you are choosing how you and your company are going to interact with the IRS. On the Internal Revenue Service W-9 form, you can select the tax classification that best suits your situation. For example, most freelancers and independent contractors operate as individuals or sole proprietorships, qualifying for the individual tax rate. They would select individuals/sole proprietorship as their federal tax classification.

From a business perspective, business tax classifications are a matter of how you want to be treated by the Internal Revenue Service from a tax perspective. How much do you have to pay, and how do you want your company viewed by the IRS?

How Does Compensation Fit Into My Tax Planning?

Consider good tax practices as part of your research. Knowing your company tax classification is a key part of your discussions with your CPA, and this is where a good CPA is invaluable. Your company will likely be one of the following: 

• C Corporation
• S Corporation
• Sole Proprietorship
• Limited Liability Company
• Partnership

Each classification will influence whether you take an owner draw or salary. Each classification has its own rules and regulations to follow and will dictate how you get paid.

Outsourcing payroll services is one way to simplify payroll for yourself. You would have a professional working for you who understands the ups and downs of payroll tax regulations and keeps track of deadlines. Hiring out does incur additional expenses, so weigh this option carefully.

How Do You Determine Your Worth?

Now that you have decided between an owner draw or a salary, it’s time to decide what is reasonable pay and what is not. Here are the key business indicators I use to determine compensation.

Business Performance

Your compensation is not set in stone. There is some flexibility to paying yourself depending on the performance or “success” of the business.  

Business Growth

As part of your business plan and continued business review, you will want to put profits back into the business to support growth. To reinvest and receive the compensation, you need to be aware of the company’s needs and what growth phase you are in.

Reasonable Compensation

What is the value that would ordinarily be paid for like services by like businesses under like circumstances. There are many factors to determine the reasonableness of your compensation. Your qualifications, the type of work, the company’s industry, business conditions, and comparable salaries are just a few considerations used to determine compensation.

The amount you get paid will also depend on the profitability of your business. Your business plan needs to include funding for payroll. The more money you bring into the company, the more likely you will realize a profit. The more profit, the higher salary/draw you can expect to take from it.

Personal vs Business Expenses 

Your compensation is dependent on how much revenue comes into the company and how much money is going out for expenses. If you take an owner draw, your personal expenses will figure into how much you take and what may be too much to draw. This awareness will aid you in determining the correct amount to draw.

What’s the Best Way to Keep Track My Financials?

Unless you love have a photographic memory, keeping all your financial details in your head is difficult. Consider investing in a computerized accounting system for your company. 

Accounting Software Helps:

• Automate your accounting
• Improve your efficiency
• Simplify filing your taxes
• Creates proper documentation (aka audit protection)
• Tracks a running history of your business
• Supports budgeting and planning
• Shows your cash flow

 

Why Do I Need to Plan My Compensation?

Putting a value on your own worth is difficult. It is crucial not to undervalue your work and your contributions. Consider some confidence-building tips:

• Reach for your dreams – Most of us, especially women entrepreneurs, tend to limit our compensation by having low expectations of ourselves. Strive to value yourself and your work at market levels.
• Know what you bring to the table – Keep a file of everything you have done professionally, review it often.  
• Find what motivates you – Live into your motivation every single day.  
• Challenge yourself – Learning new skills will keep your motivation fresh and support the growth of your business.
• Practice daily affirmations – Attitude is everything, and keeping positive influences around you, in your heart and in your mind, supports your psyche and provides encouragement when you need it.

 

Being a business owner requires confidence. Paying yourself commensurate with your skill level and work ethic is part of having the confidence to make your dreams come true.