When you own the business, paying yourself should be the easiest part. After all, it’s your business. Surely you can just transfer some money into your personal account whenever you want to…right?
Well…not exactly.
The way you pay yourself determines how much tax you pay and whether you (accidentally) create a compliance headache for future-you. Making careful decisions today will save you a lot of money (and stress!) later on.
Let’s break down the difference between salaries and distributions, who can use each method, and how to pay yourself without giving Uncle Sam a penny more than you have to.
What is a salary?
This is when you pay yourself as an employee of your own business through payroll. Taxes are withheld from each paycheck, just like they would be for any other employee. Depending on your business structure, paying yourself a salary may not just be an option – it could be an IRS requirement.
Note that this option isn’t available to everyone. Sole proprietors and partners in a partnership can’t pay themselves a salary through traditional payroll. That’s because, for tax purposes, they’re treated as both the employer and the employee – and you can’t legally be an employee of yourself. Instead, these business owners typically pay themselves through an owner’s draw.
If you own an S Corporation or C Corporation and actively work in the business, the IRS generally expects you to pay yourself a reasonable salary before taking any profits out of the business.
But wait…what counts as reasonable?
It should be similar to what you’d pay someone else to do the same job. Paying yourself $10,000 a year while your business brings in hundreds of thousands is likely to raise a few eyebrows.
The biggest benefit of taking a salary is consistency. You receive regular paychecks, stay compliant with IRS rules, and make budgeting a little easier. The downside? You’ll need to run payroll and deal with a bit more admin – but it’s a small price to pay for keeping the IRS guys off your back.
What are distributions?
This is money you take out of your business profits without putting yourself through payroll. Unlike a salary, there are no regular paychecks or taxes withheld when you take the money out. Instead, the tax treatment depends on how your business is structured.
They’re most commonly used by S Corporation owners after they’ve paid themselves a reasonable salary. Once your salary is sorted, you can take additional profits from the business as distributions. The best part? These payments aren’t subject to self-employment tax in the same way a salary is, which can create some valuable tax savings when everything is set up properly.
But before you start thinking, “Great, I’ll just skip the salary and take everything as distributions,” hold that thought. The IRS has rules around this for a reason, and trying to game the system can create a much bigger headache than the tax savings are worth.
When used the right way, distributions can be a smart tool for keeping more of your hard-earned money. The trick is finding the right balance between paying yourself a salary and taking profits out of the business.
Salary vs distributions: Which one is right for you?
Unfortunately, there’s no magic formula here (we know, a little frustrating). The best way to pay yourself mostly depends on how your business is structured and how much profit you’re making,
Let’s break that down a bit better.
Sole proprietors, single-member LLCs, partnerships, and MMLLC
If you’re a sole proprietor or a single-member LLC, you can’t pay yourself a salary or get a traditional paycheck. Instead, you take what’s called an owner’s draw. This is a fancy way of saying you transfer money from your business account to your personal account when you need it.
But keep in mind, moving that money doesn’t change your tax bill. You’re taxed on your total business net profit. This stands regardless of whether you transfer the cash to yourself or leave it sitting in your business account.
S Corporation owners
This is where the salary vs distributions conversation gets a little more interesting.
If you own an S Corp and actively work in the business, you’ll generally need to pay yourself a reasonable salary first. After that, you can take any remaining profits as distributions.
This can be a great tax strategy when done correctly, but the balance matters. Trying to pay yourself a tiny salary and take the rest as distributions might seem like a smart move at first, but it’s the kind of thing that can attract unwanted attention from the IRS.
The goal isn’t to avoid paying yourself a salary, it’s to find the right balance between salary and distributions based on your role, your income, and your business.
C Corporation owners
C Corporation owners work a little differently. Since the corporation is its own separate entity, you’re usually treated like an employee of the business, which means you’ll typically pay yourself through payroll.
Unlike an S Corporation, taking additional money out of a C Corp usually isn’t handled the same way through distributions. Instead, owners may take profits out through dividends, depending on the company’s situation and overall tax strategy.
The right approach depends on how much you’re earning and what you want to do with the business. For example, do you plan to reinvest profits back into the company?
The bottom line
How you take your money comes down to your entity type and cash flow.
If you’re a sole proprietor or partner in a partnership, you draw what you need and focus on setting aside money for quarterly taxes. If you’re an S Corp, you shift gears to balancing a fair salary with your distributions.
Nailing this setup protects your business as it grows, keeping you compliant and preventing an unexpected tax bill or an IRS audit.
Need help figuring out how to pay yourself?
If you’re still scratching your head over whether you should be taking a salary, distributions, or something else entirely, don’t sweat it.
The Tax Savvy Advisors team helps you pick the right entity structure, nail down a smart payment strategy, and avoid messy IRS red flags.
Take our Fit & Pricing Quiz and we’ll help you figure out the right next step.
