Small businesses are the fastest growing segment of our economy. Businesses vary from traditional brick and mortar shops to online stores selling T-Shirts, Jewelry, and many other consumers goods. With advancements in technology, the barriers to starting a small business are diminishing.
Small business owners find out quickly that they are responsible for making critical business decisions daily. Early on, the primary focus is to get the business profitable. No minor achievement. Once profitable, now the new business owner must decide what his or her compensation will be.
When profits are small, the amount to pay yourself is easy. It will be driven by what the business cash flow can afford. As profits grow, the decision becomes more complex. Issues with distributions, payroll, taxes, etc. become the drivers in finding what the best approach for owner payroll is.
Salaries for Small Business owners are as varied as the small businesses themselves. The web has numerous sources that provide ranges and average pay. On this site, Indeed.com provides basic information that you can use to gain an understanding on a few elements of owner pay. Small Business Owners Business Owner Salary in United States (indeed.com).
Another site provided by Payscale, Small Business Owner Salary, Payscale details average payroll for Small Business owners based on years of experience.
There is no right or wrong answer for the amount you pay yourself, but there is always the IRS out there looking to ensure there is a reasonable amount of tax paid for any compensation you choose to take.
IRS Guidance for reasonable compensation
The Internal Revenue Service has, as with most things, very strong views on how small business owners should pay themselves. The following is guidance on what it deems to be Reasonable Compensation.
Because an officer of a corporation is generally an employee with wages subject to withholding, corporate officers may question what is considered reasonable compensation for the efforts they contribute to conducting their trade or business. Wages paid to you as an officer of a corporation should generally be commensurate with your duties. Refer to “Employee’s Pay, Tests for Deducting Pay” in Publication 535,Business Expenses for more information. Public libraries may have reference sources that provide averages of compensation paid for various types of services. The Internal Revenue Service may determine that adjustments must be made to the income and expenses of tax returns for both the corporation and an individual shareholder if the officer is substantially underpaid for services provided.
The IRS provides additional information about owner’s compensation at Paying Yourself | Internal Revenue Service (irs.gov).
The best approach for owner compensation may be difficult to define. Each business has its unique conditions and what the best approach may be varies. One thing for sure, defining an approach that is in line with IRS guidance, will save you the difficulties of dealing with the IRS on Tax issues.
While the internet provides an almost endless amount of information on this topic, getting advice from a competent professional is always the best course of action to take. Speak with your CPA, attorney, and seek the advice from your peers in the industry.
Our firm works with many clients on these and many other issues related to payroll for owners and employees. To learn more about our Consulting Services or to discuss how we may assist your organization, please Contact Us.