How to Pay Yourself as a US Business Owner (LLC, S-Corp, Sole Prop)

One of the most common and critical questions for new entrepreneurs is, “How do I pay myself?” The answer is not a simple one-size-fits-all solution. In fact, it depends entirely on your business’s legal and tax structure. Getting it wrong can lead to serious tax penalties, but with the right payroll services in the US, you can unlock significant tax savings.

This guide breaks down the correct way to compensate yourself for three common business structures in the US.

The Core Difference: Owner’s Draw vs. Salary

Before diving into specific business types, you must understand the two primary ways to pay yourself:

• Owner’s Draw: This is a withdrawal of money from the business’s bank account for personal use. It is a bookkeeping entry that reduces the owner’s equity. However, an owner’s draw is not a tax-deductible business expense, and it is not subject to payroll tax withholding.
• Salary (W-2): This is a regular, fixed payment made through payroll, just like for any other employee. A salary is a tax-deductible business expense. In addition, it is subject to payroll tax withholdings (Social Security, Medicare, and federal income tax).

Therefore, the business structure you choose dictates which of these methods you can, and should, use.

Sole Proprietorship: The Owner’s Draw

A Sole Proprietorship is the simplest business structure. For tax purposes, the IRS considers you and your business to be the same entity.

• How to Pay Yourself: You pay yourself with an owner’s draw. You can transfer money from your business bank account to your personal account whenever you want and in any amount you choose, as long as the business has the cash.
• Tax Implications: You are not an employee of your business. Consequently, you do not receive a W-2, and no taxes are withheld from your draws. All of the business’s net profit “passes through” to your personal tax return (Form 1040, Schedule C). You are responsible for paying self-employment tax (the full 15.3% for Social Security and Medicare) and income tax on the full net profit, regardless of how much you withdraw in draws. This is why you must set aside a portion of your profits for taxes.

LLC: It Depends on Your Tax Filing Status

The Limited Liability Company (LLC) is a flexible business structure. How you pay yourself depends on how the LLC is taxed.

Single-Member LLC (Default Tax Status)

By default, a single-member LLC is a “disregarded entity” and is taxed as a Sole Proprietorship.

• How to Pay Yourself: You pay yourself with an owner’s draw.
• Tax Implications: The same tax rules as a Sole Proprietorship apply. You will pay self-employment tax and income tax on the business’s net profit.

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Multi-Member LLC (Default Tax Status)

A multi-member LLC is taxed by default as a Partnership.

• How to Pay Yourself: Each partner takes an owner’s draw from their share of the business profits.
• Tax Implications: Partners are not employees. The business’s profits and losses “pass through” to each partner’s personal tax return (Form 1040, Schedule K-1). Each partner is responsible for paying self-employment tax and income tax on their share of the profits.

S-Corporation: Salary and Distributions

An S-Corporation is a corporation that has elected a special tax status with the IRS. This structure is typically chosen for tax savings, but it comes with stricter rules for owner compensation.

• How to Pay Yourself: The IRS requires any owner who actively works in the business to pay themselves a “reasonable salary” via a W-2 paycheck. A reasonable salary is the amount a comparable business would pay an employee for similar services. Any remaining business profits can then be taken as a distribution.
• Tax Implications: The salary portion of your income is subject to all federal payroll taxes. The distribution portion, however, is not subject to the 15.3% FICA (Social Security and Medicare) tax, which can result in significant tax savings. The IRS is very strict on the “reasonable salary” rule, so you must be prepared to justify your salary amount if audited.

Summary

Successfully navigating the process of paying yourself as a business owner depends on your business’s legal structure. For sole proprietors and LLCs, the proper way to take money from the business is through an owner’s draw, which is a withdrawal of money for personal use. These business owners are then personally responsible for paying self-employment tax and income tax on all business profits, regardless of how much they withdraw. By contrast, S-Corporation owners who work in the business must pay themselves a “reasonable salary” via a W-2, which is subject to payroll taxes. Any remaining profits can then be taken as tax-advantaged distributions, which are not subject to self-employment tax.

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