A recent survey found that 73% of small-business owners funded their startup businesses primarily with personal savings. Additionally, it cost the average business owner $10,000 to get the venture off the ground. (1)

Even though small-business owners put a lot into their companies, including time and capital, sometimes it’s hard to determine exactly how much to take out. When figuring an appropriate salary, there are several factors to keep in mind.

Taxes

The way the IRS taxes an owner’s compensation is partially determined by the way a business is structured. Company profits for C corporations are taxed at the corporate rate, and the owner’s salary may be deductible. With corporations, taking home too great a percentage of profits may violate some IRS guidelines. With most other forms of ownership, such as sole proprietorships, limited liability companies, and general partnerships, business profits are considered earned income and are taxed at the owner’s personal tax rate.

Retirement Savings

Depending on how their businesses are organized, some business owners may be able to take advantage of tax benefits by taking less salary and contributing to qualified retirement plans. Owners may be eligible to save up to 25% of their earned income in some cases, while reducing their income tax burden. Distributions from qualified retirement plans are taxed as ordinary income and may be subject to an additional 10% federal income tax penalty if taken prior to reaching age 59½. Profits can also be used to fund benefits such as life, health, and disability income insurance for the owner and the employees.

Growth and Profitability

Obviously, a business owner can’t take home what isn’t there. But even when business is booming, it isn’t always the best idea to take whatever is left over after paying the bills. In order to avoid stagnation, some profits can be reinvested in the business to help it continue to grow. Profits can be used to modernize equipment, expand the business, and increase marketing efforts. Using extra capital as a buffer against lean times may also be helpful.

You built your business with your blood, sweat, tears, and cash. Knowing when and how much to take out can be a tricky balancing act, but one that will hopefully pay off for both you and your business.

1) Journal of Financial Planning, November 2006

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