4 Reasons Why Business Owners Need to Pay Themselves First
Post by Apex President and Business Broker Doug Hubler, Certified M&A Professional (CM&AP)
As a business owner, you may be tempted to avoid paying yourself a conventional salary. After all, payroll is an extra expense, right? Who needs those employment, Social Security and Medicare taxes? Plus, the bottom line will look a lot better if you don’t take a paycheck, correct?
Not exactly. I’d like to take a few minutes to bust those myths and ask you to consider the advantages of paying yourself a reasonable salary from your business.
1.You lose the opportunity for retirement savings and the associated tax deductions.
If you don’t take a paycheck, you can’t take advantage of tax deferred retirement plans such as deferred comp, 401(k) or SEP accounts. That means you miss out on saving for retirement.
Considering the power of compounding, skipping just a few years of retirement savings can put a big dent in your potential nest egg. Foregoing a paycheck and retirement savings also means you may actually pay more taxes.
2.Your Social Security payments will suffer.
If you don’t take a salary or take too little, you could be reducing the amount of your Social Security benefit. According to Investopedia, your benefit is based on your highest 35 years of earnings.
If you don’t record income for at least 35 years, the formula inserts $0.0 for the missing years and indexes your benefit accordingly.
3.You could run into problems with the IRS.
Paying yourself too little or not at all can also create problems with the IRS. The IRS expects you to pay yourself a reasonable salary for a person in your position. I’m a small business owner myself, so I understand how hard this decision can be.
I worked with my financial advisor, Joe Pribula at Wells Fargo, to come up with a salary amount that made sense given the needs of my business, my family and my retirement goals.
4.You skew your business valuation.
When you go to sell your business, your paycheck will factor into the company’s valuation. Most buyers will want to see how their personal income needs match with what the sellers’ salaries have been. And taking no salary or commingling your personal expenses with those of the business will confuse that picture significantly.
Buyers and their bankers won’t understand why a seller wasn’t able to pay himself a salary when the business shows a consistent profit. They will see red flags instead. Believe me, you don’t want to be going backwards and trying to correct or adjust your books when it’s time to sell.
If you’re not sure how much to pay yourself, you might want to consult with an accountant or a tax specialist. At the minimum, you’ll want to consider:
- Funding your own personal needs
- Maximizing your tax-deductible savings
- Keeping enough cash in the business to supply working capital for three months or more
If you or someone you know is interested in buying or selling a business, please call us at 913-383-2671 or contact one of our Apex Business Advisors today!
