Should You Give Yourself a Raise?
by Mark Henricks
In the beginning, many small business owners receive no salary. However, as the business grows and becomes profitable, owners start taking money back. At that point, new questions arise. How much should you pay yourself? And at what point should you give yourself a raise?
Determining an Owner's Salary
One approach for the owner, at least in the early days of the business, is to take a salary that is just sufficient to cover basic needs. Starting with a personal budget for outlays such as housing, food, healthcare, clothing, and transportation, the owner can allocate enough of the business's cash to cover those expenses, and reinvests the rest into the business.
An owner should increase this base salary with annual or similar raises to reflect increases in cost of living, just as any employee would receive. This minimum base can be further supplemented with annual or quarterly bonuses if profits are sufficient and there is enough cash on hand that taking it out as a bonus won't harm the business.
Alternatively, instead of basing the owner's salary on living costs, it can be based on market rates. You can do this by finding out the average earnings of owners or CEOs in businesses in the same industry, in the same region, and of similar size. This information can be obtained from trade groups and from employment websites that include salary and wages.
Other Factors of Entrepreneur Salaries
Along with these common sense concerns, tax rules must be kept in mind. A sole proprietor who takes nothing in salary may draw the risk of having the business classified as a hobby by the Internal Revenue Service.This could mean that past expenses taken as businesses deductions could be disallowed, possibly creating a potentially significant tax liability.
Owners of incorporated businesses have more tax issues to keep in mind. An officer of a corporation is required by the IRS to receive wages that are generally commensurate with the duties the officer performs. This usually means paying yourself a market wage similar to what your business or one like yours would pay someone to do your job.
There are a number of other complex IRS rules covering how compensation, distributions, draws, and dividends are treated for tax purposes. Because of these complexities, it's absolutely essential that you discuss your plans for your salary and compensation with your accountant or financial advisor.
Your Investors and Partners
Investors also need to be considered. Investors and lenders generally do not want to fund a business that is only viable as long as the owner takes little or no salary. If you have been taking a very small salary, it may be advisable to demonstrate the business's profitability, stability, and long-term viability before approaching investors and lenders and taking a larger salary.
Finally, partners must be taken into account. A partner who is also an employee may feel entitled to earn as much or more than you, depending on the relative difficulty and value of the services each of you provides to the business. A partner who is an investor but does not work in the business may receive less, depending on the value and size of the financial support provided.
As the owner, you can raise or reduce your compensation to meet your personal needs or the needs of the business. If you're saving for a down payment on a home, you may want to increase your compensation. On the other hand, if the business is going through a rough patch, you may want to take a temporary pay cut to help out.
Whatever you decide to pay yourself, be flexible.
About This Author
Mark Henricks is a freelance journalist covering business, entrepreneurship, technology, personal finance, health and fitness for leading publications.
Cash Flow Challenges
Insights on the top cash flow challenges business owners are facing today.
Browse All Articles »
Sign Up Now
Receive an email with featured articles and valuable insights for today’s business owners.
We've Made One Business Decision Easier —
Business Checking from PNC
Earn a cash reward when you open a qualifying PNC business checking account by 9/14/18. Get Offer Details »
Start Your Cash Flow Conversation
Give us a call at 1-855-762-2365 or fill out our simple form and a PNC Business Banking representative will get in touch with you.
Request a Contact »
Important Legal Disclosures and Information
PNC is a registered mark of The PNC Financial Services Group, Inc. (“PNC”). This article has been prepared for general information purposes by the author who is solely responsible for its contents. The opinions expressed in these articles are those of the author and do not necessarily reflect the opinions of PNC or any of its affiliates, directors, officers or employees. This article is not intended to provide legal, tax or accounting advice or to suggest that you engage in any specific transaction, including with respect to any securities of PNC, and does not purport to be comprehensive. Under no circumstances should any information contained in the presentation, the webinar or the materials presented be used or considered as an offer or commitment, or a solicitation of an offer or commitment, to participate in any particular transaction or strategy or should it be considered legal or tax advice. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Neither PNC Bank nor any other subsidiary of The PNC Financial Services Group, Inc., will be responsible for any consequences of reliance upon any opinion or statement contained here, or any omission. Banking and lending products and services, bank deposit products, and Treasury Management products and services for healthcare providers and payers are provided by PNC Bank, National Association, a wholly owned subsidiary of PNC and Member FDIC. Lending and leasing products and services, including card services and merchant services, as well as certain other banking products and services, may require credit approval.