One of the most common questions we get from business owners is deceptively simple: “How do I actually pay myself?” The answer, however, depends entirely on your business structure, your profit levels, and your personal financial needs. If you’re taking random draws whenever you need money, not paying yourself at all (essentially working for free!), or taking more than your business can actually afford, you’re not alone. These patterns create unnecessary stress, unexpected tax surprises, and serious cash flow problems. The solution isn’t complicated, but it does require understanding your business structure and implementing a systematic approach to owner compensation. Today we’re covering the two most common business structures and giving you a clear roadmap for paying yourself properly.
Why Flying Blind with Owner Pay Creates Problems
Many business owners fall into one of three problematic patterns when it comes to compensation:
Taking random draws without any planning. When you pay yourself based on your bank balance or immediate needs rather than actual profit, you create cash flow instability and make strategic business planning nearly impossible.
Not paying themselves at all. Many entrepreneurs, especially in growth phases, sacrifice personal compensation entirely. While short-term sacrifice might be necessary, working indefinitely without proper compensation isn’t sustainable and often leads to burnout or resentment.
Taking more than their business can actually afford. Without clear profit tracking, it’s easy to withdraw more than your business generates, slowly depleting reserves and creating financial instability.
The common thread? Operating without a system based on your business structure and actual financial performance.
Business Structure Matters – A Lot
How you legally pay yourself depends entirely on how your business is structured. While there are several business entity types, we’re focusing on the two most common structures for online service providers:
- Sole Proprietorship/Single Member LLC: Owner’s draws
- S-Corporation: Payroll plus distributions
If you’re operating as a partnership or multi-member LLC, the rules become more complex with partnership distributions and guaranteed payments. That’s a conversation for another day (and likely one that requires professional guidance specific to your situation).
Sole Proprietorship and Single Member LLC: The Owner’s Draw Method
How It Works
As a sole proprietor or single-member LLC owner, you pay yourself through “owner’s draws.” This is essentially transferring money from your business account to your personal account – as simple as it sounds. These draws aren’t technically a salary or wage. You’re withdrawing your own money from your own business. There are no payroll taxes withheld from draws, but you will pay self-employment tax on your business profits.
Here’s a crucial point many business owners miss: You get taxed on your business profits regardless of how much you actually take in draws. If you profit $50,000 – whether you draw $1 or $49,999, you are taxed on that $50,000. However, you still want to be strategic about when and how much you withdraw to maintain business cash flow and reserves.
The Right Way to Take Owner’s Draws
Step 1: Know Your Actual Profit
You can’t pay yourself what you don’t have. This seems obvious, but many business owners look at their bank balance rather than their actual profit when deciding on draws.
Your monthly profit calculation is straightforward: Revenue – All Business Expenses = Profit
This means you need current, accurate bookkeeping. If your books are months behind, you’re making withdrawal decisions based on incomplete information.
Step 2: Set Aside Taxes First
Before taking any draws, save 25-30% of your profit for taxes in a separate savings account. Bonus points if it’s a high-yield savings account so your tax savings are at least earning interest while waiting for tax payments. This isn’t optional or something to “figure out later.” The IRS will want their cut when your taxes are due, so you might as well save it as you go rather than scrambling when tax bills arrive.
Step 3: Determine Your Draw Percentage
After setting aside taxes, you can safely take 50-75% of what remains as your personal draw. The exact percentage depends on several factors:
Your business season: Newer businesses typically need to retain more cash for operations and unexpected expenses. Established businesses with consistent revenue can usually take higher draw percentages.
Personal financial needs: What do you actually need to cover your personal expenses? Your draw should align with your personal budget rather than being arbitrary.
Business investment plans: If you’re planning equipment purchases, team expansion, or other investments, you’ll need to retain more cash in the business.
Emergency fund status: Both your business and personal finances need emergency reserves. If either is lacking, prioritize building those reserves before maximizing draws.
Real-World Example
Let’s walk through a practical example:
- Monthly profit: $10,000
- Tax savings (30%): $3,000
- Available for draw: $7,000
- Conservative draw (60%): $4,200
- Remains in business: $2,800 for operations and growth
In this scenario, you’re paying yourself $4,200 monthly while maintaining business reserves and staying current on tax obligations. The $2,800 remaining in the business supports cash flow needs, unexpected expenses, and strategic investments.
Frequency and Planning
Find a draw schedule that works for you – monthly or twice-monthly are common starting points. The key is consistency and planning based on actual profit rather than hoped-for or projected income. Track everything meticulously. Your draws, while not technically wages, still need clear documentation for your records and tax preparation.
Biggest Mistakes to Avoid
Taking more than your actual profit. This depletes business reserves and creates cash flow problems that compound over time.
Random draws without planning. Inconsistent, need-based withdrawals make both business and personal financial planning impossible.
Not saving for taxes first. This creates massive stress when tax payments come due and you haven’t set aside adequate funds.
S-Corporation: Salary Plus Distributions
How It Works
As an S-Corporation owner, you’re technically an employee of your own company. This structure requires paying yourself a “reasonable salary” through proper payroll, and you can take additional compensation as distributions. This dual-compensation approach provides tax advantages but comes with additional complexity and compliance requirements.
The Reasonable Salary Requirement
The IRS requires S-Corp owners who work in the business to pay themselves a “reasonable salary.” This means approximately what you’d pay someone else to do your job.
Important note: Your tax preparer determines what constitutes reasonable compensation for your specific situation – not your bookkeeper and not yourself. This determination considers your role, industry standards, business profitability, and other factors.
Your salary must run through proper payroll with all appropriate tax withholdings. This isn’t optional or something you want to do yourself.
Our Recommended 60/40 Split
For most service-based business owners, we recommend a 60/40 split between salary and distributions:
- 60% as W-2 salary through payroll
- 40% as distributions
Example: If you want to take home $100,000 annually, structure it as $60,000 in salary and $40,000 in distributions.
This ratio balances tax efficiency with IRS compliance. Taking too little salary relative to distributions raises red flags, while taking too much eliminates the tax benefits of the S-Corp structure.
Setting Up Payroll Properly
We don’t recommend handling S-Corp payroll yourself. The complexity and compliance requirements make DIY payroll risky and time-consuming. We recommend using Gusto for straightforward setup and reliable processing. Payroll mistakes are expensive in terms of penalties, corrections, and potential audits, so getting help with payroll setup is ideal.
Tax Advantages of the S-Corp Structure
The primary tax benefit of S-Corp status is that distributions avoid self-employment tax (Social Security and Medicare taxes). Only your salary portion is subject to these taxes. This can create significant tax savings compared to sole proprietorship structures where all profit is subject to self-employment tax. However, you need sufficient profit to make the structure worthwhile.
Our general guideline: Wait until you’re consistently profiting at least $70,000 annually before considering S-Corp election. Below this threshold, the additional complexity, administrative burden, and costs often outweigh the tax benefits.
Key Tax Implications by Structure
Sole Proprietorship and Single Member LLC
- Pay self-employment tax (15.3%) on all business profit
- Quarterly estimated tax payments are highly recommended to avoid penalties
- Owner’s draws don’t reduce your taxable income
- Simpler tax filing – business income reports on your personal return
S-Corporation
- Payroll taxes apply only to salary portion
- Distributions generally not subject to self-employment tax
- More complex tax filing requirements including a separate business tax return
- Additional compliance and accounting costs
Universal Best Practices for Both Structures
Regardless of your business structure, certain principles apply:
- Plan for taxes throughout the year, not just at filing time
- Keep detailed records of all payments to yourself
- Work with qualified tax professionals who understand your business structure
- Review your compensation strategy at least annually
When to Consider Professional Help
Consider getting professional financial guidance if:
- You’re struggling to determine your actual profit due to bookkeeping issues
- You need help setting up proper systems for owner compensation
- You’re considering switching business structures and want to understand the implications
- Your business has grown significantly and your current approach no longer works
- You’re experiencing cash flow stress despite seemingly good revenue
At 1428 Financial, we work with service-based business owners on exactly these issues. We help you understand your true profitability, set up systems for consistent owner compensation, and make informed decisions about business structure optimization.
Your Action Plan for Proper Owner Compensation
If you’re a Sole Proprietor or Single Member LLC:
- Get your bookkeeping current so you know your actual profit
- Set up a separate savings account for taxes
- Calculate a safe draw percentage based on your situation
- Establish a consistent draw schedule
- Track all withdrawals meticulously
If you’re an S-Corporation:
- Work with your tax preparer to determine reasonable salary
- Set up proper payroll processing (we recommend Gusto)
- Plan for the 60/40 salary-to-distribution split
- Stay compliant with all payroll tax obligations
- Review your compensation strategy annually
Regardless of structure:
- Base decisions on actual profit, not bank balance
- Always set aside taxes before taking owner pay
- Plan consistently rather than withdrawing reactively
- Keep detailed records for tax purposes
Getting the Framework Right
Paying yourself as a business owner doesn’t have to be complicated, but it does require a systematic approach based on your business structure and actual financial performance.
The framework we’ve outlined works for most service-based businesses, but every situation has unique considerations. If you’re unsure about the right approach for your specific circumstances, professional guidance can save you both money and stress. Ready to implement a proper owner compensation system? Book a consultation with us to discuss your specific situation and develop a plan that works for both your business and personal financial goals. Because when you pay yourself strategically based on your business structure and actual profits, you create sustainability for both your business and your personal financial life.
The content in this blog post is provided for general informational purposes only and should not be considered professional tax or legal advice. The author is not a Certified Public Accountant, and no assurances can be made regarding the outcomes or consequences of tax returns, IRS actions, or any financial decisions based on this information. Readers are strongly advised to consult with a qualified tax professional or legal advisor for personalized guidance specific to their individual circumstances. The author expressly disclaims any liability for decisions made based on the information presented in this blog post.
