Owner’s Draw Vs Salary: Paying Yourself As A Business Owner
From legal filings and insurance to marketing plans and more, there’s a lot to worry about as a new business owner before you can get your business off the ground. Once you’ve taken care of the basics, you’ll also need to consider how you’ll pay yourself for your role. Since it can be challenging to predict your cash flow, you may be wondering whether it’s best to pay yourself an owner’s draw vs salary. We’ll break down the differences between these two approaches here to help you decide.
In this article, we’ll explain how owner’s draw vs salary stack up in terms of factors like the type of business you run, the amount of equity you have, your salary, and tax implications. After reading this, you’ll understand the top things to consider when deciding whether an owner’s draw or salary is the better option for how to pay yourself as a business owner.
How do business owners pay themselves?
There are two common ways for business owners to get paid: to either take an owner’s draw or receive a salary.
What is an owner’s draw?
With an owner’s draw, you’ll take money from the business’ profits, or capital you’ve previously contributed, by writing yourself a check or depositing funds into your personal bank account. You can take fixed draws at regular times or as needed. Since owner draws are discretionary, you’ll have the flexibility to take out more or fewer funds based on how the business is doing.
What is a salary?
A salary is a set, recurring payment that you’ll receive every pay period that includes payroll tax withholdings. When deciding what to pay yourself, you’ll want to take into account your expected profit and expenses. As your circumstances change, you can always give yourself a raise or take a pay cut if needed.
Which is the best way to pay yourself? Owner’s Draw vs Salary
When you’re evaluating the best method to pay yourself, there are several factors to consider. Here are some of the top things to think about:
- The type of business you run
- The amount of equity you have in the business
- Tax Implications
- How much you pay yourself
The Type of Business You Run
Your company’s business structure is the biggest factor when it comes to deciding whether to pay yourself an owner’s draw vs salary since you may be limited in your choices based on how your business is set up.
For example, if you run a partnership, you can’t pay yourself a salary because you technically can’t be both a partner and an employee. In this case, you’d need to take an owner’s draw. While partners often split income evenly, that doesn’t have to be the case so you can arrange a different income draw based on your partnership agreement.
Likewise, if you’re an owner of a sole proprietorship, you’re considered self-employed so you wouldn’t be paid a salary but instead take an owner’s draw. Single-member LLC owners are also considered sole proprietors for tax purposes, so they would take a draw.
On the other hand, owners of corporations or S-corporations generally can’t take a draw and would typically be paid a business owner salary instead. Just remember that if you own an S-corporation, your salary must be considered reasonable compensation, which we’ll discuss in a bit.
The Amount of Equity You Have in the Business
If you plan to take an owner’s draw, it’s important to understand that the amount of your total draw for the year can’t be more than the equity you have in the business.
Your equity is defined as the amount of accumulated value you’ve invested into the business through things like cash, equipment, and other assets.
While you can opt to take out all the equity in your owner’s draw, you’ll have to consider the impact that could have on your business’ continued operations and whether that would allow you to pay your expenses and invest in future growth.
When you take an owner’s draw, no taxes are taken out at the time of the draw. However, since the draw is considered taxable income, you’ll have to pay your own federal, state, Social Security, and Medicare taxes when you file your individual tax return. The tax rate for Social Security and Medicare taxes is effectively 15.3%.
If you take a draw, you may be responsible for making quarterly estimated tax payments as well depending on what you’ll expect to owe in taxes for the year.
If you pay yourself a salary, like any other employee, payroll taxes like federal, state, Social Security, and Medicare will be automatically taken out of your paycheck. Because your company is paying half of your Social Security and Medicare taxes, you’ll only pay 7.65% ‒ half what you’ll pay if you take an owner’s draw.
While you’ll still be paying these taxes as the business owner, the advantage of being a salaried employee is that you won’t have to worry about calculating and paying the taxes at tax time. And your salary is treated as a business expense, which can reduce your company’s net income.
Keep in mind that if you’re an S-corporation owner, you may also have to report pass-through profits on your tax return in addition to the salary you receive from the corporation.
How Much You Pay Yourself
No matter what option you choose, you’ll want to be mindful of your business’s current and future expenses and pay yourself in a way that allows you to take care of your liabilities.
As we already talked about, your only limit on the amount of an owner’s draw is that your total take for the year can’t be more than your equity in the business.
With a salary, you can decide on any wage to pay yourself. However, as we discussed earlier, if you own an S-corporation, your salary must be considered reasonable compensation.
There are no specific guidelines for what constitutes reasonable compensation. However, the IRS says training and experience, duties and responsibilities, time and effort devoted to the business, what comparable businesses pay for similar services, and payments to non-shareholder employees are factors to consider. It’s important to carefully consider these in determining your salary to avoid an IRS audit.
So, should I pay myself via an owner’s draw or salary?
Paying yourself is just one of many expenses you’ll have as a new business owner. And figuring out how to compensate yourself can be tricky. It’s important to weigh the legal guidelines and varying levels of risk and liability associated with the different business structures as well as what makes the most sense for the business in deciding whether to take a draw or be a salaried employee.
If you’re able to choose freely between the two options, generally speaking, an owner’s draw is best if you:
- Want more flexibility in what and when you pay yourself based on the performance of the business
- Are unsure of what your cash flow will be
A salary is a better fit if you:
- Don’t want to worry about calculating taxes on your pay
- Want more stability with your paycheck
- Believe it’s easier to have a set salary for tracking expenses and managing cash flow
As you get your new business up and running, your owner compensation is one of the things you’ll need to consider to make sure you meet your legal obligations and stay in compliance.Read our guide for first-time business owners to learn 10 key steps you can take to get your new venture off to a successful start.
This blog was originally published in January of 2021 and was updated in June of 2023 for accuracy and comprehensiveness.