Owner's Draw Versus Salary: Let's Untangle This Together
- Jun 3
- 4 min read
How we pay ourselves as business owners comes with some confusion… but to be honest, we’ll take confusion over a boss any day!
To untangle the owner’s draw versus salary web, we first have to chat about business structures. So, let’s start with the foundation first.
Business Structures
Common Business Structures
Here are the most common business structures for small business owners.
Sole Proprietorship
Limited Liability Corporation (LLC)
S-Corporation (S-Corp)
Aside from Sole Proprietorship, you can’t just declare your structure/status to the world and call it good.
And, if you’re just getting started, Mango Marketing has a great quick-read on starting a business the right way – including the reminder to treat your business like a business from day one. Understanding your business structure fits into that advice perfectly! So let’s get into it…
If you want to become an LLC or S-Corp, you have to register with your state to make that declaration.
I am currently a resident of South Dakota, and my registration is through the Secretary of State, which is the case with MOST states. A few states require you to go through a different office, so make sure you check with your state.
I went through a Registered Agent company called Northwest; they handled the whole state registration for me after collecting all the necessary info. I was happy to pay them to make sure everything was completed correctly! Just make sure you check state costs first, as some services charge hefty fees because they are soulless.
Moving from LLC to S-Corp
I don’t want to chat much about this because it’s not the point of the post, but I do want to put out a cautionary tale about not selecting S-Corp status too soon. It’s a tough decision to undo, and if you proceed before the costs outweigh the benefits, you’re going to be sad paying all those extra fees just to deduct your payroll.
All that to say– make sure you run that decision by your accountant and/or tax strategist before moving forward.
Owner’s Draw Versus Salary
Now that you have the business structure context, here’s where it gets interesting… so hold on to your hats!
Owner’s Draw
The term “owner’s draw” refers to a Sole Proprietorship or an LLC business. It means a payment from the business to the owner.
An interchangeable phrase you may see is “owner’s pay.” It means the same thing.
It doesn’t matter how much this payment is or when it occurs. It’s up to you (the owner)! Although I highly recommend using a schedule, because “when I feel like it” doesn’t lend itself to stability for your household.
A few other tidbits:
All owners’ draw is subject to the full self-employment tax rate. These taxes cover Social Security and Medicare.
Your owner’s draw IS NOT a tax deduction
Salary
The term “salary” refers to an S-Corp business. It means a payment from the business to the owner.
With this business structure, you are required to pay yourself (the employee) a “reasonable salary” on a schedule. You may be thinking to yourself, "What is a reasonable salary?!” which is a very valid question. From the IRS’s perspective, a reasonable salary is similar to what someone else in a W2 position would get paid for the same line of work.
If you’re considering this route, I highly recommend chatting with your accountant to ensure the salary you’ve set is acceptable. For example, if your business is bringing in $250k and a W2 employee would make approximately $75k for the work, you can’t set your salary at $30k just to get better tax benefits.
So, now let’s chat about the JUICY part!
If you’re paying yourself a reasonable salary, but there is still more profit available to you, this is where distributions come in. You get to pay yourself “extra.” In finance jargon, a distribution is a non-wage transfer of cash from the corporation to its shareholders (you), representing a payout of company profits, which is not subject to self-employment tax.
Read that again… not subject to self-employment tax. Hallelujah!
Salary & Distributions Recap
Salary:
It’s the base of what your business pays you
It must be deemed “reasonable” in order to avoid penalties (no thanks)
You pay payroll taxes on all salary payments
Paid on a schedule
Your salary IS a tax deduction
Distributions:
It’s the cherry on top of your salary
You do not pay payroll taxes on distribution payments
Paid whenever you see fit
There is no maximum, but you can’t exceed available profits
Your distributions ARE NOT a tax deduction
I hope that clears up what the difference is between an owner’s draw and a salary! I’m going to reiterate a point from above… although it looks very enticing to be an S-Corp, making that declaration without running the tax savings against the added fees has led many entrepreneurs to regret that move. Please make that decision with informed data. Your future self (and your accountant) will thank you.
Understanding the structure is step one. Deciding what to do with the knowledge is where I come in. I help service-based entrepreneurs get comfortable with how they pay themselves (and how much overall)... and everything that comes with running a money-healthy business! If any of that feels like your vibe, come join the “Getting Comfy with Money” email newsletter!
About the Writer
Melissa Mittelstaedt is an Accredited Financial Counselor (AFC®) and virtual financial coach/consultant for small business owners who are ready to get comfy with money. Her financial journey truly began once she realized that life after college couldn’t be forged on student loans and credit cards alone. She's spent 17 years in various forms of self-employment, so her zone of genius is seeing the whole money journey, from your business account to the life you're building. Melissa has been featured on 20+ podcasts, talking money mindset, financial strategy, and everything in between. Check them out at melissamitt.com/podcast-features.
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