Owner's Draw vs. Salary
Owner's Draw vs. Salary: What's the Difference, and Which One Is Right for You?
This is one of the questions we get asked the most, and it makes sense why - "how do I pay myself" sounds like it should have a simple answer, and then you start researching and it gets confusing fast. So let's break it down.
The short version
Owner's draw is when you take money out of the business for yourself, and it's not run through payroll.
Salary is when you pay yourself like an employee, through payroll, with taxes withheld along the way.
Which one applies to you depends almost entirely on how your business is structured. Here's what we would walk through.
If you're a sole proprietor or a single-member LLC
You're taking an owner's draw. There's no separate "salary" option here, because the IRS doesn't see you and the business as separate entities - the business's profit is your income, whether you pull the cash out or leave it sitting in the account. You'll pay self-employment tax on the business's profit either way, so how much you draw out doesn't change your tax bill. It's really more of a cash flow decision than a tax one.
If you're a partnership
Same idea as above - partners generally take draws, not a salary, and each partner pays self-employment tax on their share of the profit.
If you're an S-corp
This is where it gets more specific, and where it trips people up the most. As an S-Corp owner who works in the business, the IRS expects you to pay yourself a reasonable salary through payroll before you take any additional money out as a distribution (which functions similarly to a draw).
"Reasonable" is doing a lot of work in that sentence, and it's exactly the kind of thing that's worth a real conversation about, since it depends on your role, your industry, and what similar positions typically pay. But here's the general idea: the salary gets taxed like any employee's paycheck - Social Security, Medicare, income tax withholding. The distributions on top of that are not subject to self-employment tax, which is the reason a lot of business owners choose the S-Corp structure in the first place.
Why this actually matters
A few reasons this isn't just a technicality:
The IRS pays attention to this one. Underpaying yourself a salary as an S-corp owner, so more of your money can flow through as a distribution instead, is a known red flag and can lead to penalties if it's audited.
It affects your personal financial picture. Salary shows up as income you can use to qualify for things like a mortgage. Draws and distributions can be harder to document in the same way.
It changes your tax withholding. Salary has taxes taken out along the way. Draws don't, so if that's your only income from the business, you'll want to be setting money aside for taxes yourself.
What we'd suggest
If you're not sure which situation applies to you, or what a reasonable salary would look like for your S-Corp, that's a great thing to bring to your CPA rather than guess at. Every business is different, and the right number for you depends on the specifics of what you do, your personal household, and how the business is doing.
If you have questions about how this applies to your business, we're always happy to talk it through and support your growing business!
