The way small business owners pay themselves is heavily influenced by the legal structure of their business. Whether you are a sole proprietor, part of a partnership, or own an LLC, each type carries unique rules and expectations for owner compensation. This is because different structures are taxed differently, and the IRS recognizes various types of income depending on how the business is formed. Understanding your entity type is the first step to determining how to responsibly and legally pay yourself.

What Is an Owner’s Draw

For sole proprietors and single-member LLCs, compensation usually comes in the form of an owner’s draw. Instead of receiving a consistent paycheck like traditional employees, owners take money from business profits as needed. This process is informal and flexible, but it requires diligent tracking and clear recordkeeping to avoid financial confusion or tax complications. The draw method works well for businesses without payroll systems and those that are still establishing steady revenue.

Sole Proprietorships and Their Unique Characteristics

Sole proprietorships represent the most common business structure for small ventures. They are simple to form, require minimal paperwork, and do not distinguish between the owner and the business. In this model, all profits and losses are passed directly to the owner. The owner reports income using Schedule C of Form 1040, deducting business expenses from revenue to determine net profit. That profit is then subject to income tax and self-employment tax. Since the owner does not receive a formal salary, the money withdrawn is referred to as a draw, not wages.

How Sole Proprietors Calculate Pay

Sole proprietors can choose how much to pay themselves based on their business’s financial performance. This approach offers flexibility but also requires discipline. Owners need to set aside enough money for future business needs, taxes, and potential investments before taking a draw. Calculating the appropriate draw involves reviewing monthly profits, evaluating upcoming expenses, and maintaining enough capital to keep operations running smoothly. Regular financial reviews help ensure that draws do not negatively affect the business’s health.

Paying Yourself in a Partnership

In a partnership, business profits are shared among partners rather than paid as salaries. Each partner receives a distributive share of the business income, typically based on a predefined agreement. This agreement should be created during the formation of the partnership and can be customized to reflect each partner’s investment, responsibility, or role in the company. Distributions are reported on each partner’s tax return, and partners must pay taxes on their share of the profits even if the money is not physically withdrawn.

Understanding Distributive Shares

A distributive share represents the portion of business profits allocated to each partner in a partnership. These shares are not optional; they must be reported as income by each partner regardless of whether the profits are distributed. If one partner agrees to take a smaller share for operational reasons, the partnership agreement should be updated to reflect this. Transparency and consistency are key when managing income distribution in partnerships, and these principles help avoid disputes and ensure tax compliance.

Compensation in a Multi-Member LLC

Multi-member LLCs function similarly to partnerships in terms of owner compensation. Each member receives a portion of the profits known as a distribution. These distributions are based on ownership percentages outlined in the LLC operating agreement. Like partnerships, LLCs do not pay income tax at the entity level. Instead, profits are passed through to members and reported on their returns. Members are responsible for paying taxes on their share, even if funds remain in the business for reinvestment.

Draws Versus Salaries in LLCs

LLCs are often confused with corporations when it comes to compensation. However, members of an LLC are generally not considered employees and do not receive formal salaries. Instead, single-member LLCs follow sole proprietorship rules and take draws, while multi-member LLCs follow partnership rules and receive distributions. If an LLC elects to be taxed as a corporation, compensation methods change, and the owners may then pay themselves salaries. This distinction is important because it affects how taxes are calculated and paid.

Setting a Reasonable Compensation Strategy

Small business owners often struggle with deciding how much to pay themselves. While it might be tempting to take all available profits as income, responsible financial management requires balancing personal income with the business’s operational needs. Consider costs like rent, inventory, payroll for employees, taxes, and future growth investments before determining your pay. Setting a sustainable and realistic compensation strategy allows your business to thrive while meeting your personal financial needs.

Key Questions to Help Determine Your Pay

Owners can use a set of reflective questions to help determine appropriate compensation. These include examining personal financial needs, comparing previous salaries in similar roles, considering regional income norms, evaluating the company’s financial health, and assessing future growth plans. For example, a founder operating in a high-cost city will likely require a different income than one based in a more affordable location. Likewise, a company with strong profits can afford a higher owner draw than one operating at a loss.

The Importance of Cash Flow in Owner Pay

Cash flow is one of the most important metrics to consider when determining how much to pay yourself. Even if a business appears profitable on paper, poor cash flow can make it difficult to pay vendors, employees, and the owner. Reviewing cash flow statements regularly helps ensure the business can support consistent owner compensation. Avoid drawing large sums during periods of low revenue or high expenditure, as this can destabilize business finances.

Paying Yourself Modestly During Startup Phases

New business owners often need to keep personal compensation low during the early stages. This strategy helps conserve business capital, fund initial investments, and cover operational expenses. Some entrepreneurs even choose to forgo pay entirely until the company becomes profitable. While this approach can be financially challenging, it may be necessary to support long-term sustainability. To prepare, it’s advisable to save enough personal funds to cover living expenses for several months before launching a business.

Planning for Pay Increases Over Time

Once a business begins generating consistent revenue, owners can reassess their compensation. This might include gradually increasing draws or distributions, especially if the business achieves growth milestones or hits profitability targets. Tying pay raises to specific financial goals creates motivation while ensuring the company remains financially stable. Planning for periodic increases also helps avoid sudden jumps in operating expenses, which can disrupt budgeting and forecasting.

Creating a Financial Safety Net

Establishing a financial safety net is essential for business owners who want to pay themselves responsibly. Building a reserve of funds allows owners to continue paying themselves even during revenue downturns or unexpected challenges. A healthy savings cushion also supports strategic decision-making, such as hiring new staff or launching marketing campaigns, without compromising personal income. This approach balances personal security with business growth.

Utilizing Tools to Simplify Compensation Decisions

Several financial tools can help small business owners determine how much to pay themselves. These include budgeting apps, accounting software, and income calculators designed for entrepreneurs. These tools analyze variables such as operating expenses, revenue trends, and tax obligations to suggest an appropriate salary or draw. Using technology to inform pay decisions reduces guesswork and increases financial accuracy.

The Consequences of Overpaying Yourself

Paying yourself too much too soon can have negative consequences for your business. It can deplete working capital, create cash flow shortages, and reduce funds available for reinvestment. It may also affect your ability to pay taxes or qualify for business loans. Responsible compensation is not just about personal income; it is about supporting the long-term success and stability of your company. Regular financial assessments help prevent overpayment and maintain a balanced budget.

Monitoring Financial Health to Guide Pay Decisions

Regularly reviewing financial reports such as income statements, balance sheets, and cash flow statements is essential to guide pay decisions. These reports provide a snapshot of the business’s overall health and help identify trends that may affect owner compensation. For instance, a drop in sales may signal the need to temporarily reduce pay, while a consistent increase in profits may justify a raise. Data-driven decision-making leads to more sustainable pay practices.

Preparing for Taxes and Withholding Obligations

While draws and distributions are not subject to traditional payroll withholding, owners must still prepare for tax liabilities. This includes self-employment tax, income tax, and estimated quarterly payments. Failure to account for these obligations can result in unexpected tax bills and penalties. Keeping a portion of each draw or distribution aside for taxes ensures that you are prepared when payments are due. Proper planning also helps avoid disruptions to your personal or business finances.

Understanding How to Pay Yourself as a Partner in a Partnership

Running a business with one or more partners introduces unique dynamics to managing compensation. In a partnership, the way partners pay themselves differs significantly from other business structures. Rather than receiving a traditional salary or draw like in a sole proprietorship, partners take what is known as a distributive share. This method of compensation aligns with the collaborative and contractual nature of partnerships and must reflect the agreements between the individuals who co-own the business.

What Is a Distributive Share and How Does It Work

A distributive share, sometimes referred to as a distribution, is the portion of a partnership’s profits or losses that is allocated to each partner based on the ownership agreement. This concept means partners receive earnings in proportion to their agreed-upon share in the business, rather than a fixed salary or predetermined amount. These shares are typically determined in a legal partnership agreement that should be in place before the business begins operations.

For example, if two partners agree to split profits and losses evenly, each would receive 50 percent of the distributive share regardless of how much each contributed in time or capital. Alternatively, the agreement might outline a more complex formula that factors in specific roles, capital contributions, or workload.

The Legal Framework Behind Partnership Compensation

The structure of compensation in a partnership is defined by a formal agreement known as a partnership agreement. This document outlines every detail about how the business is managed, including how profits and losses are distributed, what happens if a partner leaves, and how disputes are resolved. If a partnership operates without such an agreement, it is subject to default rules set by the state in which it is registered, which might not reflect the partners’ preferences or business reality.

A well-crafted partnership agreement should specifically state the percentage each partner is entitled to and under what circumstances distributions will be made. Without clear documentation, disagreements can easily arise, especially when the business begins to generate significant revenue or if it faces financial difficulties.

Tax Implications of Partner Compensation

Unlike a corporation, a partnership itself does not pay income taxes. Instead, it operates as a pass-through entity. This means all profits and losses flow directly to the individual partners, who then report this income on their tax returns. Each partner receives a Schedule K-1 from the partnership, which details their share of the business’s income, deductions, and credits. This ensures that the tax obligations remain transparent and properly distributed.

Because partners are not considered employees by the IRS, they do not receive wages or salaries. As a result, income tax is not withheld from their distributive share. Instead, partners are required to make estimated quarterly tax payments to cover both federal and state income taxes, along with self-employment taxes.

Understanding Guaranteed Payments in Partnerships

In some cases, partners may receive what is called a guaranteed payment. This is a form of compensation that is paid to a partner for services rendered or for the use of capital, regardless of whether the partnership makes a profit. Guaranteed payments are especially common in partnerships where one or more partners handle specific roles or management responsibilities and need to be compensated regularly for that work.

Guaranteed payments are similar to a salary in that they are fixed amounts and are paid regularly. However, they are still not considered wages for tax purposes. These payments are deductible business expenses for the partnership and must be reported on the partner’s Schedule K-1 as ordinary income, subject to self-employment tax.

Managing Cash Flow While Paying Partners

One of the most important factors in deciding how much to distribute to partners is the business’s cash flow. Since partnerships do not withhold taxes or issue salaries, all distributions come directly from the company’s available profits. This requires careful financial management to ensure that the business maintains enough liquidity to meet its operational needs while still compensating the partners appropriately.

Partners should consider leaving a portion of profits in the business as retained earnings to support future growth, cover unforeseen expenses, or invest in new opportunities. Taking out too much money too soon can put the partnership at risk and limit its long-term sustainability.

Establishing a Compensation Policy Among Partners

To avoid confusion and ensure equity among partners, it is helpful to establish a written compensation policy. This policy should outline the process for determining distributive shares, guaranteed payments (if any), the timing of distributions, and how the business will handle profit shortfalls or periods of loss.

A clear policy helps set expectations and ensures that all partners are on the same page. It also provides a mechanism for resolving disputes that may arise when financial results do not meet expectations or when one partner believes they are contributing more than others.

Adjusting Compensation as the Business Grows

As a partnership evolves, the way partners are paid might need to be adjusted. In the early stages of a business, it may be reasonable for partners to receive minimal compensation or reinvest most of their earnings back into the business. However, as the business becomes profitable and stabilizes, partners should revisit their compensation plan to reflect the changing financial situation.

Changes in business goals, roles, or partner contributions should prompt a reevaluation of distributive shares or guaranteed payments. Revising the partnership agreement to reflect these changes ensures that the compensation remains fair and relevant.

Handling Partner Contributions and Reimbursements

Besides profit distributions, partnerships may also need to handle reimbursements for out-of-pocket expenses paid by partners on behalf of the business. This includes costs such as travel, supplies, or other business-related expenses. These reimbursements should not be considered income and must be carefully documented to avoid confusion with distributive shares.

In addition, partners may contribute capital to the business, either at the time of formation or later during operations. These contributions are tracked separately from profit distributions and may entitle the contributing partner to a larger share of future profits or a higher repayment priority if the business dissolves.

Communication and Transparency Among Partners

Open and consistent communication is essential when managing compensation in a partnership. Each partner must understand how profits are calculated, how much money is available for distribution, and when they can expect payments. Transparency builds trust and helps avoid misunderstandings or resentment, particularly if profits fluctuate or if partners feel the compensation structure is unfair.

Regular financial reports, scheduled meetings to discuss cash flow, and clear documentation of all distributions can help maintain transparency and foster strong working relationships among partners.

Considerations for Adding New Partners

When new partners are added to an existing partnership, the compensation structure may need to be reevaluated. The incoming partner must agree to the terms of the partnership, including how profits and losses are distributed and what level of compensation they can expect. This often requires amending the original partnership agreement and recalculating distributive shares for all partners.

New partners may also bring in capital or specialized skills that justify different compensation arrangements, such as larger guaranteed payments or a higher share of profits. These adjustments must be clearly documented and communicated to avoid future conflict.

The Role of Professional Guidance in Partner Compensation

Managing compensation in a partnership can be complex, especially when dealing with multiple partners, fluctuating profits, or legal obligations. Professional advice from an accountant or business attorney is often necessary to ensure that the compensation structure is legally compliant, financially sustainable, and aligned with the goals of all partners.

Accountants can help calculate accurate profit margins, ensure tax compliance, and advise on the best methods for handling distributions. Legal professionals can assist in drafting or revising partnership agreements and resolving disputes that may arise regarding compensation.

Planning for Long-Term Success

Ultimately, the way partners pay themselves should support the long-term goals of the business. While it’s tempting to maximize individual income, maintaining a healthy financial foundation is essential for sustainability and growth. Partners who prioritize the financial health of the partnership and collaborate to ensure fair compensation practices are more likely to build a successful and lasting enterprise.

Establishing clear policies, maintaining open communication, and revisiting compensation arrangements regularly ensures that the partnership remains strong and adaptive to changing business needs. With careful planning and collaboration, paying yourself as a partner can be both financially rewarding and strategically sound.

How to Pay Yourself in an LLC (Single-Member and Multi-Member)

A Limited Liability Company (LLC) offers small business owners flexibility, liability protection, and simplicity in taxation. It’s one of the most popular business structures for entrepreneurs in the United States. But when it comes to paying yourself as an LLC owner, the process depends heavily on how your LLC is structured and taxed. We explore everything you need to know about taking a draw, receiving distributions, and complying with the tax code as the owner of a single-member or multi-member LLC.

Understanding the Basics: What Is an LLC?

An LLC is a business structure that combines the liability protection of a corporation with the tax simplicity of a sole proprietorship or partnership. It is governed by state law, and its owners—called members—can be individuals, corporations, or even other LLCs. LLCs can be managed by members directly or by appointed managers.

For federal tax purposes, the IRS does not recognize an LLC as a separate tax classification. Instead, an LLC must elect how it wants to be taxed—by default, a single-member LLC is taxed as a sole proprietorship, and a multi-member LLC is taxed as a partnership. However, LLCs can choose to be taxed as a corporation or an S corporation by filing the appropriate forms.

Paying Yourself in a Single-Member LLC (Sole Proprietor Tax Status)

Member’s Draws

If your LLC has only one member and is not taxed as a corporation, the IRS views it as a “disregarded entity.” That means the business’s income and expenses are reported on your tax return using Schedule C. You don’t pay yourself a traditional salary. Instead, you take what’s known as an owner’s draw.

You can withdraw funds from the business at any time, provided you keep adequate records and your business maintains enough capital to function. These draws are not tax-deductible business expenses and do not impact the business’s taxable income. Rather, they represent the transfer of equity from the business to the owner.

How to Record Draws

Draws should be recorded in your accounting software or books as a reduction in owner’s equity. This is essential for maintaining accurate records and ensuring your tax filings are correct.

Example:
If you started your LLC with a $10,000 capital contribution and withdrew $3,000 later in the year, your equity account should show a remaining $7,000 balance. Tracking this helps you understand how much value you have left in the business.

Paying Yourself in a Multi-Member LLC (Partnership Tax Status)

When an LLC has two or more members and hasn’t elected to be taxed as a corporation, the IRS treats it as a partnership. The payment process is more complex than with single-member LLCs.

Distributive Shares

Each member is entitled to a portion of the profits and losses, called a distributive share, which is usually outlined in the LLC’s operating agreement. The default rule is that profits and losses are split evenly among the members, but the operating agreement can allocate them differently.

These distributions are not wages, and no taxes are withheld. Each member receives a Schedule K-1 annually, which details their share of the income, deductions, and credits. These figures are then used to report the earnings on their personal tax returns.

Guaranteed Payments

Sometimes, LLC members may perform work for the company or contribute capital. To compensate them reliably, LLCs can issue guaranteed payments. These are fixed payments made to members regardless of the company’s profitability. Unlike draws or distributions, guaranteed payments are considered earned income and are subject to self-employment tax.

They are also deductible expenses for the LLC, which lowers the business’s taxable income.

Capital Accounts

Each member has a capital account that reflects their initial investment, additional contributions, share of profits, distributions, and guaranteed payments. These accounts are critical for calculating each member’s equity in the business and for determining how much they can withdraw without affecting the business’s financial health.

Electing Corporate Tax Treatment (C Corporation or S Corporation)

Some LLCs choose to be taxed as a C corporation or an S corporation. This can be beneficial in certain scenarios, especially if the owners want to reduce self-employment taxes or reinvest profits into the business.

LLC Taxed as a C Corporation

If your LLC elects to be taxed as a C corporation, it becomes a separate tax entity. You, as the owner, become an employee and must be paid a reasonable salary through payroll. You’ll pay income tax and FICA taxes (Social Security and Medicare) on your wages, while the business pays its corporate taxes on profits.

Any dividends you take beyond your salary are also subject to taxation, which leads to what’s known as double taxation—once at the corporate level, and again at the personal level.

This structure is less common for small LLCs due to its complexity and tax implications.

LLC Taxed as an S Corporation

An LLC can also elect to be taxed as an S corporation, which may offer some tax advantages. In this case, you must be paid a reasonable salary for the work you perform, and any additional income can be taken as distributions, which are not subject to self-employment tax.

This hybrid structure requires running payroll, filing W-2s, and maintaining accurate books. However, the potential savings on self-employment taxes can make it worthwhile for LLCs generating significant profits.

Tax Considerations for LLC Owners

No matter how your LLC is taxed, it’s essential to understand your tax obligations.

Self-Employment Tax

Unless your LLC is taxed as a corporation, your income is subject to self-employment tax, which covers Social Security and Medicare contributions. In 2025, the self-employment tax rate is 15.3% on the first $168,600 of net income, and 2.9% on any amount beyond that (plus an additional 0.9% Medicare tax for high earners).

Estimated Quarterly Payments

Because taxes aren’t automatically withheld from LLC draws or distributions, owners are responsible for making quarterly estimated tax payments to the IRS and, where applicable, their state tax agency. Failure to make timely payments can result in penalties.

Recordkeeping and Compliance

Maintaining clean records is non-negotiable. LLC owners should track:

• All draws and distributions

• Capital contributions

• Business expenses

• Revenue and profits

• Payroll (if applicable)

Using reliable accounting software can simplify this process, and hiring a bookkeeper or CPA is a smart move as your business grows.

How Much Should You Pay Yourself?

The answer depends on the following:

• Business profits: Never withdraw more than your company can afford.

• Reinvestment needs: Consider saving a portion of profits to reinvest in growth.

• Personal expenses: Your draw should at least cover your essential living costs.

• Tax implications: Distributions may be more tax-friendly than guaranteed payments or wages, depending on your tax structure.

A good rule of thumb is to pay yourself a percentage of profits after setting aside funds for taxes, reinvestment, and operating reserves. For S corp owners, ensure your salary is “reasonable” to avoid IRS scrutiny.

LLC Operating Agreement and Compensation Policy

Your LLC’s operating agreement should clearly state:

• How much and how often members can take distributions

• Guidelines for guaranteed payments

• Procedures for adding or removing members

• Voting rights related to compensation changes

This agreement provides structure and prevents disputes, particularly in multi-member LLCs.

When to Seek Professional Help

If your LLC is earning consistent revenue, planning to scale, or considering a change in tax election, working with a tax advisor or accountant is crucial. They can:

• Help you determine the most tax-efficient way to pay yourself

• File necessary forms for corporate tax elections

• Handle payroll and tax filings.

Keep you compliant with local, state, and federal regulations.

How to Pay Yourself in an S Corporation

S Corporations (S corps) offer small business owners one of the most tax-efficient ways to pay themselves, blending the structure of a corporation with the simplicity of pass-through taxation. But this efficiency comes with strict IRS rules, and failing to navigate them carefully can lead to penalties and unexpected tax bills.

We’ll explore everything you need to know about paying yourself as an S-Corp owner: how salaries and distributions work, what the IRS considers a “reasonable salary,” and how to make smart compensation choices that minimize tax exposure while remaining compliant.

What Is an S Corporation?

An S Corporation is not a legal entity but a tax election made by eligible corporations or LLCs. The S corp status allows profits (and some losses) to pass directly to owners without being taxed at the corporate level, avoiding the double taxation that C corporations face. This makes S corps particularly attractive to small business owners who want to draw a salary and still take additional profit distributions in a tax-efficient way.

To become an S corp, a corporation or LLC must file Form 2553 with the IRS and meet specific requirements:

• No more than 100 shareholders

• All shareholders must be U.S. citizens or residents.

• Must issue only one class of stock

• Must be a domestic entity

Owner Compensation in an S Corporation

The most important aspect of paying yourself as an S-Corp owner is striking the right balance between salary and distributions.

1. Reasonable Salary

The IRS requires that S corp owners who are active in the business,  especially those providing significant services, must pay themselves a reasonable salary before taking profit distributions. This salary must be comparable to what someone else would earn doing a similar job in your industry, location, and experience level.

The salary must:

• Be paid through the company’s payroll system

• Be subject to payroll taxes (Social Security, Medicare, and unemployment)

• Follow federal and state withholding laws.

• It will be reported on a W-2 at year-end.

Why is this necessary?
Because payroll taxes are only applied to wages, not to distributions, the IRS wants to ensure that business owners aren’t avoiding taxes by paying themselves entirely in distributions. Failing to take a reasonable salary can trigger audits and penalties.

2. Distributions (aka Dividends)

Once a reasonable salary is established and paid, additional profits can be withdrawn as owner distributions, which are not subject to payroll taxes. This creates a strategic opportunity to reduce your overall tax burden.

Distributions:

• Are not subject to FICA (Social Security & Medicare) taxes

• Are taxed once at the shareholder level (pass-through income)

• Should only be taken if the business has sufficient profits and reserves

Example:
Suppose your S corp has a net profit of $100,000. You determine that a reasonable salary for your role is $60,000. You pay yourself $60,000 in wages (with payroll taxes withheld) and take the remaining $40,000 as a distribution. That $40,000 is not subject to payroll taxes, resulting in potential tax savings.

What Is a Reasonable Salary?

There is no fixed rule for what constitutes a “reasonable” salary, but the IRS provides guidance and expects owners to consider:

• Duties performed

• Time devoted to the business

• Compensation of non-owner employees in similar roles

• Local industry standards

• Training and experience

• Complexity of the business

• Cost of living in your area

If audited, you must provide documentation that supports your salary determination. This can include salary surveys, job listings, or advice from an accountant.

Warning: Paying yourself a $20,000 salary when your S corp earns $200,000 is likely to raise a red flag with the IRS.

How to Set Up Payroll for an S Corporation

To pay yourself a salary, you must run payroll just as you would for any employee:

1. Register with federal and state tax agencies
   Get an EIN (Employer Identification Number), register for payroll taxes, and obtain any necessary state tax accounts.

2. Set up a payroll system.
   Use payroll software or a payroll service provider to automate tax calculations, withholdings, and filings.

3. Calculate and withhold taxes.
   Withhold federal income tax, Social Security (6.2%), and Medicare (1.45%) from wages. The S corp matches the Social Security and Medicare contributions.

4. File payroll tax reports.
   File Form 941 quarterly and Form 940 annually. W-2s and W-3s must be filed by January 31 each year.

Other Considerations for Paying Yourself as an S Corp Owner

1. Timing of Distributions

Distributions can be taken periodically (monthly, quarterly, annually), but should be timed carefully. Do not take large distributions if the business doesn’t have sufficient profits or if it would affect the company’s ability to meet obligations.

2. Health Insurance

If the S corp pays your health insurance premiums, the amount must be reported as taxable income on your W-2. However, you can deduct these premiums on your return as an adjustment to income (above-the-line deduction), reducing your taxable income.

3. Retirement Contributions

As an S-Corp employee, you can participate in retirement plans such as a Solo 401(k) or SEP-IRA.

• Solo 401(k): You can contribute both as an employee (up to $23,000 in 2025, or $30,500 if 50+) and as an employer (up to 25% of your salary), with total contributions capped at $69,000 in 2025.

• SEP-IRA: Employer contributions only, up to 25% of your salary or $69,000 (2025 cap).

Distributions are not counted when calculating retirement contributions—only your salary counts.

Common Mistakes to Avoid

1. Not Paying a Salary at All
   This is the biggest red flag and can trigger penalties. If you work in your business, you must pay yourself a salary.

2. Setting Salary Too Low
   A token salary to maximize distributions may lead to IRS scrutiny. Always base your salary on market data.

3. Misclassifying Employees as Contractors
   If your S corp hires others, make sure they are properly classified to avoid employment tax violations.

4. Taking Distributions Without Profits
   You can’t distribute more than your business earns. Doing so could be considered a return of capital and lead to legal issues.

5. Failing to File S Corp Election on Time
   To be taxed as an S corp in the current tax year, Form 2553 must generally be filed within 2.5 months of the start of the tax year (e.g., March 15 if your fiscal year starts January 1).

How Much Should You Pay Yourself?

There’s no one-size-fits-all answer, but here’s a rough guideline:

• Pay yourself a reasonable salary first,  typically 40%–60% of your business profits.

• Take the remaining as distributions, if profits allow.

• Keep enough working capital in the business to handle expenses and growth.

Example:
Your business makes $120,000 in profit. You determine that $60,000 is a reasonable salary. You take:

• $60,000 salary (with payroll taxes withheld)

• $60,000 as distributions (no payroll tax)

You save roughly $9,000 in self-employment taxes compared to taking the full $120,000 as salary.

Working With an Accountant or Payroll Provider

Managing corporate compliance and payroll can be complex, especially as your business grows. A qualified CPA or payroll provider can:

• Help determine a reasonable salary

• Handle payroll taxes and filings..

• Prepare quarterly and annual payroll reports.

• Ensure timely distributions and tax compliance.

• Advise on retirement and tax-saving strategies

Final Thoughts

S corporations offer powerful tax advantages—but only when handled correctly. Paying yourself involves more than just transferring funds. You must:

• Establish and document a reasonable salary

• Pay that salary through a formal payroll.

• Take additional profits as distribution..
• Maintain good records for all payments.

• Stay current on tax filings and compliance.

By understanding and applying these principles, you can maximize your income, reduce unnecessary taxes, and build a sustainable financial future for both you and your business.

Whether you’re switching from an LLC or launching your first S corp, the path to compensation clarity starts with the right structure and smart, informed choices. Use this guide as a blueprint and consult with tax professionals who can tailor these strategies to your specific needs.