The business is finally making money. You have clients, projects are moving, and the bank account looks healthier than it did in the early days. At some point, you naturally start wondering how you’re actually supposed to pay yourself.
It should be simple, right? After all, you own the business.
But once taxes, business structures, and IRS rules come into play, it stops feeling quite so simple. Some owners take an owner’s draw. Others run payroll and pay themselves a salary. In some situations, a combination of both makes sense.
The right approach depends largely on how your business is structured and how income moves through it. Understanding your options can help you avoid hiccups at tax time and make more informed financial decisions throughout the year.
Should I take an owner’s draw or pay myself a salary?
This is a question we hear over and over again from small business owners, and part of the confusion is that there isn’t just one way to do it.
For many owners, especially sole proprietors, partnerships, and certain LLCs, paying yourself often means transferring money from the business to your personal account. This type of payment is commonly called an owner’s draw, and the income from the business is typically reported on your personal tax return.
Businesses taxed as S corporations or C corporations operate a little differently. Owners who actively work in those businesses generally pay themselves a salary through payroll. For S corporation owners, the IRS expects that salary to be considered reasonable before additional profits are taken as distributions.
Paying yourself as a business owner might seem like it’s just transferring money from one account to another, but there’s more to it. The approach you choose can affect your taxes, your cash flow, and how your business grows over time.
How to Choose the Right Way to Pay Yourself
The right way to pay yourself often comes down to a few key details about how your business operates and how your finances are structured.
These steps can help you start thinking through the decision.
1. Start with how your business income is taxed
The way your business income is taxed affects how you should pay yourself. Before making any changes, it helps to understand how the money from your business flows to you and how it shows up at tax time.
2. Look at your business’s profitability
Before you can decide how much to pay yourself, it’s helpful to understand what your business can realistically support. Setting your salary before fully understanding your business’s cash flow is a bit like choosing a budget before you know what’s in your bank account. Looking closely at your profit, operating expenses, and upcoming tax obligations can help you figure out what amount is reasonable.
3. Consider the tax impact of how you pay yourself
The way you choose to pay yourself can influence how much you ultimately pay in taxes. Some payment methods involve payroll taxes, while others may trigger self-employment taxes instead. Knowing how these taxes apply can help you decide which approach makes the most sense.
4. Keep your business and personal finances separate
It can be tempting to treat the business account like an extension of your personal finances, but that habit can quickly create confusion. Keeping separate bank accounts and financial records helps everything stay organized. Paying yourself should be a deliberate transfer or payroll process, not everyday purchases made from the business account.
Should I change my business structure to save on taxes?
Sometimes questions about how you pay yourself lead to a larger conversation about your business structure.
For example, some profitable LLC owners explore electing S corporation taxation as a way to reduce self-employment taxes. In the right situation, it can create meaningful savings. In others, the added administrative requirements outweigh the potential benefit.
Every business is different, which is why this decision should be reviewed carefully. Situations like these often come up as businesses grow, and they are usually easier to navigate with the right guidance.
Finding the Right Approach for Your Business
Paying yourself as a business owner is rarely as easy as moving money from one account to another. The right approach depends on how your business is set up and how the numbers actually work.
Getting that structure right early on can make managing your finances much easier as your business grows.
If you have questions about the best way to pay yourself, we’re always happy to talk through it.
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