Disclaimer: This post is for informational purposes only and should not be taken as legal, business, or tax advice. Please consult with your accountant or business advisor for more information based on your specific situation.
Starting a business comes with many questions, and one of the most common is, “How do I pay myself?” As a business owner, compensating yourself properly is essential for maintaining both your personal finances and the financial health of your business. The way you pay yourself depends largely on your business structure. In this blog post, we’ll explore the two main methods for paying yourself — owner’s draw and salary — and how your business entity type determines which options are available to you.
Payment Options as a Business Owner
Owner’s Draw
With an owner’s draw, you can withdraw money as needed. It is the most flexible option because you can pay yourself based on your personal needs and your business performance. You can take an owner’s draw by:
Writing a check from your business to yourself
Withdrawing cash from a business bank account
Transferring money from your business bank account to your personal bank account
It's important to note that with an owner's draw, taxes are not withheld, and you'll need to set aside money to pay self-employment taxes.
Salary
A salary involves paying yourself as a W-2 employee on a regular schedule and at a fixed amount that is considered “reasonable compensation” as defined by the IRS. This means it should be comparable to salaries for someone in the same position and industry. Additionally, taxes are withheld just like a regular paycheck.
How Business Structure Affects Payment Options
Sole Proprietor and Single-Member LLC
If you operate as a sole proprietor or a single-member LLC, you can pay yourself with an owner’s draw. Since you and your business are legally considered the same entity, you cannot be considered an employee and therefore are not able to pay yourself a salary.
Partnership and Multi-Member LLC
For partnerships and multi-member LLCs, owners can also take an owner’s draw following the rules laid out in the partnership agreement. Additionally, partners have the option to receive “guaranteed payments,” which are predetermined amounts paid to partners regardless of the business’s profitability.
C-Corporation
As an owner of a C-Corporation (C-Corp), you are required to pay yourself a salary with payroll taxes withheld. In addition to a paycheck, C-Corp owners can also choose to pay themselves in the form of dividends, which are distributions of the company's profits.
S-Corporation
S-Corporation (S-Corp) owners are also required to pay themselves a reasonable salary. In addition to a paycheck, S-Corp owners can choose to take an owner’s distribution, which is similar to an owner’s draw.
LLCs have the option to be taxed as an S-Corp by filing Form 8832, Entity Classification Election.
Conclusion
The way you pay yourself as a business owner largely depends on your business structure, financial needs, and long-term goals. We recommend consulting with an accountant or business advisor to help you navigate these decisions and stay in compliance with IRS regulations. Whether you choose an owner’s draw, a salary, or a combination of both, it is vital to understand the rules and tax implications associated with your choice. Taking the time to make the right choice will help ensure your business remains financially healthy while you get the compensation you deserve.
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