Don’t think just because you’re the owner of your own company you can pay yourself anything you want. Not only could you hurt your business by paying yourself too much, but if you’re paying yourself too little, you could actually be sending the IRS a red flag to audit your business. (For more on taxes and small businss, check out the article "Micro Business Tax Savings Opportunities.")
The IRS expects your compensation, including salary and bonus, to be “within reasonable limits” and based on industry trends. So how do you figure out what works for you, your business and the IRS?
Start by researching what salary you’d be bringing in if you worked for another company in your field. As a management consultant, the amount you would make most likely depends on reputation and experience level. To find out how much someone with comparable experience would be making, try checking with your networking group or trade association. Don’t forget that salaries vary geographically and what a consultant makes in areas with a high cost of living, such as New York City or San Francisco, is not what one would make in, say, Tulsa, Oklahoma.
Then figure out how much you need to live on. Add up your living expenses, and don’t forget about putting away money for personal investments and a retirement plan. If you have a family and spouse, don’t forget their expenses and how much you need to contribute to the family budget.
What about your business—how much can it afford to pay you? Don’t forget that you now have to pay business taxes, employer taxes (if you have employees), rent, and all the overhead involved in owning a business. Consider starting with a minimal salary until the business is generating a profit and paying yourself a bonus if you have a really good year.
If the numbers aren’t adding up right, make sure you’re charging enough for your services and expertise. Look into using a billing app such as MoneyDue, which turns your appointments into payments by downloading your calendar into the app and then generating an invoice for the time spent.
Just as if you were an employee, you’ll need to plan for salary raises. Once cash flow is steady, you can tie your salary to the company’s annual growth rate. By following these tips, you’ll stay out of hot water with the IRS while still enjoying a reasonable rate of pay.
Rieva Lesonsky is CEO of GrowBiz Media, a media and custom content company focusing on small business and entrepreneurship. Email Rieva at [email protected], follow her on Google+ and Twitter.com/Rieva and visit her website, SmallBizDaily.com, to get the scoop on business trends and sign up for Rieva’s free TrendCast reports.