When you own the business, “getting paid” isn’t as simple as it sounds. How you take money out, a formal salary or an owner’s draw, depends on your business structure, and it directly affects how much tax you pay. Mix it up and you can either overpay self-employment tax or, on the other end, invite an IRS challenge. Here’s how to pay yourself the right way.
Two ways to take money out
There are really two mechanisms, and which ones are available to you depends entirely on your entity:
- Owner’s draw: you simply take money from the business’s profits. There’s no paycheck and no payroll withholding, but you owe tax (including self-employment tax) on the business’s profit regardless of how much you draw.
- Salary: you put yourself on payroll as a W-2 employee of your own company, with taxes withheld from each paycheck like any employee.
Pass-through owners: draws, but tax on profit
If you’re a sole proprietor, partner, or default LLC, you pay yourself with draws, but here’s the catch many new owners miss: your tax bill is based on the business’s profit, not on how much you withdrew. Leave money in the business and you’re still taxed on it. That’s why setting aside for taxes matters even in a year you take little out.
S-corp owners: the salary is mandatory, and scrutinized
This is where paying yourself gets strategic. An S-corp owner who works in the business must take a reasonable salary through payroll before taking the rest as distributions. The appeal is that distributions aren’t subject to self-employment/payroll tax, so a sensible salary-plus-distribution split can lower your overall tax. The risk is paying yourself an unreasonably low salary to dodge payroll tax, which is one of the things the IRS most reliably challenges for S-corps.
Don’t forget California
Running payroll for yourself in California means state payroll registration and taxes on top of the federal side, and S-corps still owe California’s 1.5% tax and $800 minimum. These costs are part of deciding whether an S-corp salary structure is worth it for your profit level.
The bottom line
How you pay yourself follows your entity: draws for pass-throughs (taxed on profit either way), and a required, defensible salary plus distributions for S-corps (where the real planning lives). Getting the salary level right is both a savings opportunity and a compliance must. We help owners set a reasonable-compensation figure they can stand behind and structure their pay to keep more of what they earn.
This article is general information, not tax or legal advice. Compensation and payroll rules are fact-specific and change; please consult a qualified professional about your specific circumstances.
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