As a business owner or entrepreneur, one of the first questions that may arise after establishing your workforce and operations is how to take your share of profits or how to pay yourself as the CEO or owner of the company. Deciding which method—salary or draw—is appropriate requires clarity about your business structure, cash flow, and overall revenue.
Paying yourself can be a daunting task if you don’t have sufficient knowledge about the basics of finance, payroll, and state and federal tax rules and regulations. If you are unsure, you may consult a professional accountant, such as a CPA in Louisville KY who has expertise and is well-established in the market.
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Understanding the Basics: Draw vs. Salary
A business owner can pay themselves using one of two methods: salary or draw.
Owner’s Draw: In this method, the business owner takes funds from the company’s account. The amount and timing are flexible, meaning you can withdraw the amount you need at any given time. However, this method affects the owner’s equity and does not require regular cash flow. Taxes are deducted at the end of the year.
Salary: Just like any other employee, the business owner receives a salary at regular pay periods. They have the authority to choose their salary amount. However, this method requires effective management of finances and cash flow.
As a business owner, how do you pay yourself?
As mentioned above, the method you choose to pay yourself should align with your business structure, rules, and regulations. You need to understand your business model, as most business entities don’t allow you to take a salary.
For a Sole Proprietor, LLC, or Partnership:
Sole proprietors, limited liability companies (LLCs), and partnerships typically use the owner’s draw method to pay themselves. For these entities, the equity balance increases with any profits or contributions in terms of assets or capital and decreases when the owner or partner takes a draw. The equity balance can also decrease if the business faces a downturn or major loss.
LLC owners can choose the method depending on how the business functions—whether as a sole proprietorship, corporation, or partnership. Profits and income from the business are treated as personal income in a single-member (sole proprietorship) LLC because the owner and the company are regarded as one and the same.
For a multiple-member LLC (partnership), the generated profits are reported to the IRS (Internal Revenue Service). There are no business tax deductions; rather, the members’ profits are considered personal income and are subject to taxation. However, if the LLC has an S Corp or C Corp model due to taxation relief or administrative operations, then the business owner will have to opt for the salary method.
For S Corp or C Corp:
If your business has an S Corp or C Corp structure, you should choose the salary method to pay yourself. You can determine the amount based on several factors, as well as the market rate for your role.
These factors include:
- Training and overall experience
- Dividend history
- Compensation agreements
- Duties and responsibilities
- Payroll or payments for regular employees
- What other businesses pay for similar services and experience
- The amount of time, energy, and commitment put into creating the company
Considering Owner’s Equity:
Equity is the amount invested in your business after excluding all liabilities and, sometimes, the owner’s draw. When someone contributes capital, assets, or equipment to their business, they are granted ownership, referred to as owner’s equity. This means the owner can withdraw their profit share from the business at the end of each year. However, if you, as a business owner, take a draw multiple times within a given period, your overall equity will be reduced. This also means your total draw amount cannot exceed your total owner’s equity.
