Paying Yourself as a Small Business Owner: A Practical Guide

What To Know About Paying Yourself as a Small Business Owner

How should you pay yourself as a small business owner? The honest answer is, “It depends.” There are a lot of variables that go into building a system that works for your situation.

It’s funny how business owners can always figure out what to pay an employee, but have a hard time figuring out what to pay themselves. It’s not that there isn’t a method to use — it’s more about determining the worth of your work and the value you bring to the business.

This post covers tips, insights, and ideas to help you build a fair system that works for you. Near the end, you’ll find a collection of resources from various authors to round out your understanding of how and what to pay yourself as a business owner. Before you get to the resources, let’s go over a few key ideas.

How Do Small Business Owners Pay Themselves?

How you should pay yourself depends on how your business is set up. We’ll go over each method briefly, but first, some food for thought.

In my opinion, this is an advanced topic, and to get it right, you should consult with your accountant and your lawyer.

You don’t want to set up your company without the advice of a professional. Can you do it yourself? Yes — there are hundreds of resources that let you set up your own LLC or corporation. But do you want to risk missing something? One mistake can cost you in taxes and liability. A professional can also advise on the best structure for your operation. For example, it may be best to start as a sole proprietorship and incorporate later.

Methods of Payment as a Business Owner

There are three methods to pay yourself when you own a business or own shares in an LLC or corporation. Some of the rules and regulations will differ depending on where you operate. If you operate outside the USA, look into the law and regulations in that country to ensure you’re compliant. Let’s briefly go over each method.

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Method One: The Draw

When you transfer money from your business account to your personal account, it’s called a draw. No taxes are deducted when you use this method. Each draw is considered part of your personal income, and you’re responsible for paying that tax when you file your personal return.

If you take a draw, consider setting aside a portion — 25%, for example — in a separate account, so the money is there when tax time comes.

Suppose you withdraw $100,000 to your personal account over the year and haven’t set your tax portion aside. You could end up owing thousands of dollars you don’t have because you’ve already spent it.

That’s a situation worth avoiding. It’s to your advantage to consult a professional accountant and plan a strategy that works for both your personal finances and your business.

Draws are used by sole proprietorships and, in some cases, LLCs. Some LLCs — and all sole proprietorships — are taxed as personal income instead of as a separate corporate entity.

Method Two: The Distribution

A distribution is similar to a draw. With a distribution, you take your percentage of the profits. Distributions are used when there’s more than one partner in an LLC.

Method Three: The Salary

When you own a corporation, you and the corporation are separate entities. The corporation pays you a salary — W-2 income subject to state and federal taxes, as well as Medicare and Social Security when applicable.

Simple Summary:

Sole Proprietorship: Draw
Single-Member LLC: Draw
Partnership LLC: Distribution
LLC Taxed as an S-Corp: Salary
Corporation: Salary

Should I Pay Myself a Salary From My LLC?

The common question is, “Should I pay myself a salary from my LLC?” It depends on how your LLC is set up — whether you’re the sole owner or have partners makes a difference.

If your LLC has elected S corporation tax treatment, the IRS requires you to pay yourself a reasonable salary before you take any profit distributions. You can withdraw additional profits as a distribution once that salary is in place.

The IRS doesn’t set a fixed dollar amount or percentage for what counts as “reasonable.” Instead, it looks at factors like what you pay non-shareholder employees for similar work, what comparable businesses pay for the same role, and your history of dividends versus wages. A useful starting point: pay yourself roughly what you’d have to pay someone else to do your job.

As mentioned above, get advice from a professional before you set this up.

What Is the Best Way to Pay Yourself as a Business Owner?

Waiting Until Your Business Is Strong and Profitable

Some business owners don’t pay themselves at all in the early going. If you can afford to do this, it’s the approach I’d recommend until the business is stable and profitable. Profit should be enough to support the business, cover monthly expenses, and leave a percentage aside for expansion and an emergency fund.

Cash flow problems are the most common reason small businesses fail — commonly cited research puts the figure at 82% of failures. Building a reserve of three to six months of operating expenses gives you a buffer against that risk. A cash reserve won’t guarantee success, but it will help you get through unexpected hardships.

Once you have that reserve in place, it’s a good time to start paying yourself.

Can You Pay Yourself?

Many business owners can’t wait for a cash reserve if they don’t have enough money to support themselves personally. They need the business to support them so they can work in it full time — otherwise, they have no personal income.

You may have heard the term “pay yourself first.” Having a personal income lets you focus on running the business instead of just making ends meet.

This is something to consider before you start a business. Does your business plan include paying you a salary? If it can’t support you, running it will be difficult, and you may need to revisit your plan.

Don’t Overpay Yourself

You’re in business because you enjoy the work, want to improve your financial situation, or want to be your own boss. All of those reasons are valid.

What you want to avoid, especially early on, is paying yourself too much. A startup sometimes sees a windfall of cash, but most companies struggle with cash in the first few years — overpaying yourself in that stretch can hurt your odds of getting through it.

One approach is to pay yourself a comparable wage — what you’d pay a manager to do your job, or a little less. The catch is that your business may not yet be able to support a manager’s wage, so you may need to take a cut or look at a lower baseline.

The key is running your business without worrying about your own living expenses. Take enough to cover what you need and leave the rest in the business. As it gains traction and stability, you can increase your pay. Early on, keep costs down — one of the main reasons small businesses fail is running out of money, so don’t pay yourself more than a struggling business can support.

How To Prove Your Income When Self-Employed

If you’re looking to buy a house, buy a car, or apply for a loan, you’ll need to provide proof of income. As a self-employed person who pays yourself, what’s the best way to do that?

Self-Employed for Two Years or More

Once you’ve been self-employed for at least two years, you can typically provide proof of income through your tax returns. Most lenders want to see two years of returns to establish a stable income pattern.

Self-Employed Under Two Years

If you’ve been in business less than two years, qualifying for a loan is harder but not impossible. You may only be able to provide one year of tax returns, along with bank statements showing your earnings, and some lenders will ask for a co-signer. A bank statement loan is also worth asking about — these let you qualify based on your cash flow rather than tax returns, though they typically carry higher rates.

Proof of Income Can Be Tricky

If you run a corporation and don’t need a large salary to live on, you might take a modest salary and reinvest the rest of the profits. That’s a good way to grow the business, but it can work against you when applying for a mortgage, since a low salary may not be enough to qualify. You may need to raise your salary for a few months before applying, to show you can afford the payments.

Key Points and Facts About Paying Yourself as a Small Business Owner

How you pay yourself depends on your business structure: draw, distribution, or salary.
Sole proprietors and single-member LLCs typically use a draw; multi-member LLCs typically use a distribution; corporations and LLCs taxed as S-corps use a salary.
S-corp owners must pay themselves a reasonable salary before taking distributions — the IRS actively enforces this.
Cash flow problems, not lack of customers, are the most common reason small businesses fail.
Lenders typically want two years of tax returns to verify self-employment income for a loan.

Action Steps for Paying Yourself as a Small Business Owner

Confirm your business structure.
- Identify whether you’re a sole proprietorship, LLC, or corporation.
- Confirm your LLC’s tax classification if applicable.
Talk to a professional.
- Review your setup with an accountant before choosing a payment method.
- Ask specifically about reasonable-salary requirements if you’re an S-corp.
Build a cash reserve first.
- Set a target of three to six months of operating expenses.
- Automate a monthly transfer into a separate reserve account.
Set a starting pay amount.
- Benchmark against what you’d pay a manager to do your job.
- Keep it modest until the business is stable.
Document your income for future loans.
- Keep two years of tax returns on hand once available.
- Keep business bank statements organized if you’re under two years in business.

FAQ: Paying Yourself as a Small Business Owner

How much should I pay myself as a small business owner?

There’s no fixed number — a common approach is to benchmark against what you’d pay a manager for the same work, then adjust down if the business can’t yet support that level.

Do I have to pay myself a salary from my LLC?

Only if your LLC has elected S-corp tax treatment. In that case, the IRS requires a reasonable salary before you take distributions.

How many years of tax returns do I need to prove self-employment income?

Most lenders want two years of returns. If you have less, a bank statement loan or additional documentation like a co-signer may help.

How much of a cash reserve should I build before paying myself?

A common guideline is three to six months of operating expenses.

Resources

As mentioned earlier in this post, here are resources from various authors to give you a fuller picture of paying yourself as a business owner.

Some go into depth, while others give an overview. Even skimming these will give you a strong background on the topic.

In my opinion, it’s good to build a solid understanding — and still speak with your accountant and lawyer to ensure you’re taking the best route for your business.

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