What Should I Pay Myself?
By Stephen Rapposelli, PT
If you are like me, you have agonized over the right answer to this age-old question. What should the “big dog” pay him or herself?
Have you ever said to yourself, “It doesn’t matter, all the profits eventually come to me anyway”? Well, if you participated in the recent Payroll Protection Program (PPP) during the COVID-19 pandemic, you certainly saw just one reason why your salary amount can have big implications.
Let’s talk about some of the factors that should go into setting your salary.
When I asked my accountant way back in the 1990s how I should set my salary, he told me that the IRS would look at the reasonableness of my salary. In other words, if I paid myself $20 as an annual salary, that is not a reasonable amount for a CEO. The IRS could assume that I was trying to shift my tax burden by pushing income away from W-2 income to corporate profit.
OK, so the extreme example made sense, but it still didn’t help me decide my salary. Back in the day, I was more of an owner/operator. By that, I mean that I was not only the CEO, I was also the physical therapist treating patients. Do I set my salary based on a physical therapist’s salary? That didn’t seem right, because I was doing all this other stuff that no other treating physical therapist would need to do. Do I set my salary based on a CEO salary? I had no way of knowing how much a CEO made! Also, what kind of CEO? An Elon Musk CEO? A coffee shop CEO?
Your accountant can help you understand your taxable rate and the implications of a change to your salary from a tax consequence standpoint. (Please note: I am not an accountant, nor am I giving you tax advice!)
If you take a high salary, you have less profit (no kidding, right?!).
A higher salary means higher amounts you can put away in a retirement plan. A higher salary means higher amount of social security payments once you retire. However, a higher salary also means paying more in taxes, which you may want to avoid. However, a lower profit margin has serious downsides. If you ever want to value your business for sale or to borrow money, banks and buyers alike will want to know your profitability. Profitability means security and decreased risk to those entities.
Brian Gallagher, PT, owner of MEG Business Academy, reminds owners that the owner’s take is often going to be considered an owner add-back in the event of a sale so all that cost can be placed back on the bottom line for the profit and loss statement, depending on what the role is in the practice for the owner.
Not many people want to buy or give money to a business that has little profit.
Planning and Budgeting
I love the book Profit First by Mike Michalowicz. In his book, he explains that businesses often (erroneously) consider profit (P) to be income (I) minus expenses (E), represented by the equation P = I -E. Michalowicz suggests that smart business owners turn the equation around and operate from a position of expenses being paid out after profit is taken from income first. This new equation would look like this: E = I – P. So, by targeting a specific amount of profit into your business first, you can better plan and budget for your success. Both salary and profit should be line items in the Expense section of your financial statement and part of a budgeted, planned business expense for the savvy CEO.
In the following table, I have outlined some advantages and disadvantages of your salary level. It is probable best practice to evaluate your salary situation at least once a year to make sure you are paying yourself a fair amount, and that you have taken into account the implications of how you choose to be compensated for the value you create in your business.
Taking a Higher Salary
Guaranteed income (as long as you cover it)
Feeds your ego
Higher amount you can put into IRA/retirement funds
Feeds your ego
May decrease any payouts to others participating in profit sharing
W-2 income is generally taxed the highest
May skew your P/L sheet from reality
Taking a Lower Salary
Guaranteed profit (as long as you take it out first)
Easier to show a profit
May run risk of IRS audit
May limit your total pay if you are profit-sharing
May skew your P/L sheet from reality
Nathan Shields of the Physical Therapy Owners Club podcast (www.ptoclub.com) and the PT Millionaires Mastermind had this to say about physical therapist owners paying themselves a salary:
“From my perspective, PT owners should take an acceptable salary equal to what they would pay another PT to perform similar duties, which may include treatment and/or admin responsibilities. I used to consider myself roughly equivalent to a clinic director when I both treated and managed in my clinic and paid myself a salary similar to what a clinic director in a small clinic would make. However, this is only a minor question in the scope of financial management and budgeting of a physical therapy clinic. Answering this question would be a small part of your monthly (yes, monthly) communication with your CPA. Physical therapist owners MUST learn to read financial statements, balance sheets, compare month-to-month and year-over-year numbers, line-item their profits (as per Profit First), etc., and that comes from sitting down with your CPA regularly and reviewing the reports. I didn’t begin to grow my business until I took my numbers seriously. But, to answer your question, personally, I would err on the side of taking a conservative wage to minimize tax implications.”
Ultimately, what you decide to pay yourself is a deeply personal decision and varies from owner to owner. You may seek outside advice from tax professionals or other business and finance experts, but only you can make such an important decision for you and your practice. Weigh the pros and cons of both higher and lower salaries—and the implications of each on the future of your practice—to help you determine the right amount for your unique situation.
Stephen Rapposelli, PT, is CEO of Performance Physical Therapy and Fitness. He can be reached at firstname.lastname@example.org.