Small business owners devote significant effort to turning their passion into profits. After overcoming the initial startup costs and managing recurring expenses, the next critical step is compensating yourself for your hard work. How you proceed with paying yourself requires careful planning, including tax considerations, fulfilling legal obligations, and understanding the nuances of your business structure.

There are two primary methods by which entrepreneurs pay themselves: a salary and an owner’s draw. Let’s dive into both types to help determine what might make the most sense for you and your business.

Understanding a Salary Versus an Owner's Draw

Salary: This is a regular payment to yourself as an employee of the company, often made biweekly or monthly, and is subject to payroll taxes (Social Security and Medicare).[1] Most business owners and employees are familiar with a salary.

Owner’s Draw: By contrast, an owner’s draw is a distribution made on an as-needed basis. There are no tax withholdings with an owner’s draw, putting the onus on you to calculate and pay your own estimated taxes each quarter.

Choosing the Right Option for Your Business

Whether to elect a salary or a series of owner’s draws may depend on your business structure.

  • S-corporations and C-corporations are more likely (and may be required) to take the salary approach, but there’s an important consideration here. The salary should be “reasonable” and not abnormally low. A smaller salary results in less payroll-tax obligation, but setting your salary under “reasonable” thresholds might run afoul with the IRS.[2] Owners of S-corporations and C-corporations can also take owner’s draws in addition to their salary. A salary may help separate personal and business finances, too.
  • Sole proprietors and single-member limited liability companies (LLCs), on the other hand, typically take owner’s draws because salaries are not an option in the eyes of the IRS. An owner’s draw may also suit business owners with fluctuating incomes.

No matter what you choose, consulting with a tax advisor may be appropriate.

Tax and Legal Implications

How you pay yourself matters in the eyes of regulators and tax authorities. For instance, taking the salary approach means you’ll have to run payroll, withhold taxes, and have a W-2 issued to you at year-end. Conversely, an owner’s draw is more flexible but also brings about more responsibilities to follow IRS rules on paying sufficient taxes as a business owner.

Determining How Much to Pay Yourself

This might be the trickiest part for small business owners, particularly if your company requires significant reinvestment. You’ll likely want to consider factors such as your business’s profitability, personal financial needs, future growth forecasts, and comparable salaries in your industry.

It may be advantageous to maintain a consistent payment schedule, and keeping good records is always paramount. You may want to consider periodically reviewing and adjusting your compensation structure as the business grows, perhaps each year. Finally, seeking professional guidance from a tax professional might help you avoid underpayment penalties or even the dreaded IRS audit.

Setting Yourself Up for Success

Paying yourself as a small business owner is not just about reaping the rewards of your hard work; it also matters greatly from a legal and tax standpoint. At PNC Bank, we support entrepreneurs seeking to grow their businesses. Our small business resources can help you strategically plan, including how best to pay yourself.