How to Pay Yourself as a Business Owner: A Guide by Business Structure

One of the most common questions new business owners ask is, “How do I pay myself?”

The answer depends on your business structure. Whether you operate as a sole proprietorship, partnership, LLC, S corporation, or C corporation determines whether you’ll pay yourself through owner draws, guaranteed payments, payroll, or dividends.

Understanding the rules can help you stay compliant, avoid tax surprises, and choose the compensation strategy that’s right for your business.

Pass-Through Entities

Several business structures, including Sole Proprietorships, Partnerships, Limited Liability Companies (LLCs), and S Corporations are considered pass-through entities, meaning their profits and losses pass through to the business owners’ individual tax returns rather than the company’s.

Pass-through business structures include:

• Sole Proprietorships
• General Partnerships
• Limited Partnerships
• Limited Liability Partnerships
• Limited Liability Companies (LLCs) (unless an LLC elects to be taxed as a
• corporation)
• S Corporations

The type of passthrough entity affects whether business owners are considered “employees” of their company and how they get paid. Here’s a breakdown of how things work for each.

How Business Owners Pay Themselves in a Sole Proprietorship

In a Sole Proprietorship, the owner(s) are not considered employees of their company. A sole proprietor may have other employees who receive wages and salaries through payroll, but the business owner may not receive compensation in the form of wages and salaries. Instead, they get paid via “owner draws,” which simply means they withdraw money from their share of the company’s profits. Typically, they do so by writing themselves a business check or transferring funds (if their bank allows it) from the business’s bank account to their personal account. There are no rules for when a sole proprietor may take draws or how much money they can take in their draws. However, stating the obvious, business owners must be cognizant of their company’s financial health to ensure they’re leaving enough money in the business to pay their company’s expenses.

Owner draws are not paychecks, so no income or self-employment taxes are withheld from them. Instead, they must report and issue quarterly estimated tax payments to the IRS because they are responsible for paying all income, Medicare, and Social Security taxes on their business profits. Most must do so on a quarterly basis by estimating the amount of profit for the quarter. In addition to federal taxes, a sole proprietor might also need to make quarterly payments to the state and local governments for income taxes.

When estimating quarterly tax obligations, sole proprietors should keep in mind that owner draws are NOT tax-deductible expenses for their business. Unlike wages and salaries to employees, draws do not lessen the amount of income subject to income or self-employment taxes. When filing their annual personal income tax return at year end, any discrepancy between what they paid throughout the year and what they owe can be settled. Overpayment results in getting a tax refund, and underpayment means the business owner must send a check or transfer funds to the tax authorities.

How Business Owners Pay Themselves in a Partnership

A Partnership is multi-owner passthrough structure with all profits and loss passing through to its owners (“partners”). Partners are not considered employees of the company and cannot receive wages and salaries. They get paid through either guaranteed payments or owner draws—or both. Partnerships report business income on the 1065 partnership tax return and issue Schedule K-1 forms to the individual partners to document their share of profit, loss, and tax obligations. Partners then report their share of the business’s profits or losses on their annual individual tax returns (Form 1040, Schedule C), and they must make quarterly estimated income and self-employment tax payments.

1. Guaranteed Payments

These are fixed payments on a regular consistent schedule made to a partner for services rendered. Guaranteed payment amounts can be different for individual partners based on how much work each partner performs for the company. The amounts should be documented in the company’s Partnership Agreement. Guaranteed payments are made whether or not the Partnership is profitable, and the business may deduct them as an ordinary business expense.

While guaranteed payments sound similar to a salary, they are not exactly the same. Both can be processed as a recurring transfer or issued through payroll, but no income taxes are withheld from guaranteed payments.

2. Owner Draws

Owner draws are the transfer of profits from a Partnership’s business bank account to partners’ personal bank accounts by direct transfer, check, or ACH transaction. How often draws are issued and the amount of funds transferred should be described in the company’s Partnership Agreement. Profits and losses could be divided equally among partners, or they might vary according to the partners’ different ownership interest percentages or the amount of work they perform or the time they spend managing the business.

How Business Owners Pay Themselves in an LLC

An LLC’s owner(s) (known as members) cannot be considered employees of their company, nor can they receive compensation in the form of wages and salaries. For tax purposes, the LLC is by default considered either a Sole Proprietorship or Partnership. Therefore, its options for how members get paid depend upon how many members own the LLC.

Single-Member LLCs

When an LLC has one member, the Internal Revenue Service (IRS) classifies the business as a disregarded entity. Essentially, that means the member and the company are considered the same tax-paying entity, and tax is applied the same as for a Sole Proprietorship.

The LLC member cannot be an employee of the company, and therefore, does not receive wages or salaries from the LLC. Instead, the member is paid via owner draws. Because no income or self-employment taxes (Medicare and Social Security) are withheld from owner draws, the LLC member is responsible for reporting the business’s profit and loss on their personal tax returns (Form 1040 Schedule C) and making estimated tax payments throughout the year.

Multiple-Member LLCs

A Multi-Member LLC has more than one member, and it files taxes as a Partnership. Members are not considered the LLC’s employees, and all business income and losses flow through to their individual tax returns. Members may be paid through guaranteed payments, owner draws, or both.

Similar to a Partnership, a Multi-Member LLC’s profits and losses might be divided equally among the partners or in varied amounts to individual members with consideration to the money each invested or the time they spend running the company. The specific details about the Multi-Member LLC’s guaranteed payments or owner draws should be included in the LLC Operating Agreement.

How Business Owners Pay Themselves in an S Corporation

As explained above, the IRS and state tax agencies treat LLCs as either Sole Proprietorships or Partnerships by default. The LLC structure has some tax flexibility, though! If an LLC meets the IRS qualification criteria, it may elect to be taxed as an S Corporation. (They also have the option of electing C Corporation tax treatment, and you’ll see more about that in the next section.)

When electing S Corporation status by filing IRS Form 2553, the company must put its owners (called “shareholders”) on the business payroll and pay them a reasonable wage or salary for the work they perform.

The company remains a pass-through entity with profits and losses ultimately flowing through to the individual owners. However, the shareholders working in the business receive wages or salaries from which income tax and Social Security and Medicare taxes (known as “FICA” when deducted through payroll) are withheld. Besides receiving a paycheck from the S Corporation, owners also receive distributions from the company’s profits according to the business’s governing documents.

Electing S Corporation tax treatment can be advantageous to LLC owners because Social Security and Medicare taxes are only applicable to wages and salaries; profit distributions made to shareholders are subject to income tax but not FICA tax. This can potentially lower shareholders’ individual self-employment tax obligations.

An entity taxed as an S Corporation must submit an information tax return (Form 1120S) while its shareholders report their wages and salaries on Form 1040 and business profit and loss on page 2 of Form 1040 Schedule E.

How Business Owners Pay Themselves in a C Corporation

By default, an incorporated for-profit entity is considered a C Corporation, which is a separate tax entity from its owners (shareholders). Shareholders who perform work for the business must be on the company’s payroll and receive wages or salaries. The Corporation must withhold Income tax and FICA tax (Social Security and Medicare taxes) from those wages or salaries. C Corporation shareholders can also receive dividend income (after-tax profit distributions based on shares of company stock).

Unlike the other business structures, an entity taxed as a C Corporation must file a corporate tax return (Form 1120) and pay corporate income tax on its profits and losses. Its shareholders report their wages and salaries on Form 1040 and dividend income on Form 1040 (Schedule B if over $1,500.00).

Like the LLC structure, a C Corporation has some flexibility in how it chooses to be taxed. It may elect S Corporation tax treatment if the business meets the IRS eligibility requirements. This may be desirable because some profits get taxed twice with traditional C Corporation tax treatment. Profits distributed as dividends are first taxed at the corporate level when the income is received and then again at the individual tax level when dividends are paid to the shareholders. S Corporation election avoids that double taxation.

A Few Things to Know About Payroll Taxes

When your business hires employees (or you are considered an employee), it’s critical to have all payroll-related details in good order.

Not only do employers have to calculate gross wages and salaries accurately, but they must also ensure all withholdings are deducted from employees’ pay and submitted to the appropriate agencies correctly. Your Employer Identification Number (EIN) serves as the tax ID for federal payroll deductions and payments, and your company will also need to register for state payroll tax accounts. You might even have to register for payroll tax accounts at the local level. Most companies use payroll software and many contract payroll services providers to handle the many aspects of managing payroll. It can also be beneficial to work with an online business filings provider who can assist with setting state payroll tax accounts because states’ processes and requirements differ.

Here’s an overview of various taxes and other employment-related expenses handled through payroll systems:

• FICA Taxes – Federal taxes comprised of Social Security and Medicare taxes. Most employers must withhold, deposit, report, and pay employment taxes per the Federal Insurance Contributions Act. FICA tax deposit due dates may be monthly or semi-weekly, depending on an employer’s total tax liability. The IRS has a next-day deposit rule; if a business accumulates $100,000 or more in accumulated FICA and federal incomes taxes in a given day, then it must make a deposit the next business day. In addition, it will temporarily convert the business to a semi-weekly depositor for the rest of the calendar year and the following calendar year.
• Federal Unemployment Tax Act (FUTA) – Federal tax that helps fund unemployment benefits for employees who lose their jobs through no fault of their own. Only employers pay FUTA taxes; no funds are withheld from employees’ wages.
• Federal Income Taxes – Withheld from employee pay based on employees’ taxable wages and information (marital status, dependents, and adjustments) on their W-4 forms.
• State Unemployment Tax (SUTA) – Required by all states; all employers must pay into their state’s unemployment benefits fund, except for qualifying 501(c)(3) nonprofits.
• State Income Tax – Required to be withheld from pay in states that collect personal income tax. Note that some states have a next-day deposit rule that’s similar to the IRS; if a business accumulates $100,000 or more in state income tax on any given day, it must make a deposit the following day.
• Paid Family and Medical Leave (PFML) – A state-level benefit offering wage replacement for workers who take time off for serious health issues, bonding with a new child, or caring for an ill or injured loved one.
• Local Payroll Taxes – A local tax (county and/or city) on employees’ income. Employers must withhold it from employees’ pay and deposit the funds to the appropriate local government agency.
• Out-of-State Payroll Taxes – Taxes from other states that must be withheld from an employer’s workers’ pay when the employee lives in a different state than where the employer’s company is located. This is more prevalent than ever with the surge of remote workers.

Besides what we’ve touched on here, other considerations come into play as well. For example, you might have to withhold voluntary deductions—such as medical and retirement plan contributions—and involuntary deductions, such as wage garnishment for child support or back taxes—from employees’ pay.

As you can see, payroll can become very complex. Payroll tax registration and managing withholdings are important compliance requirements that employers must fulfill to stay in good standing, avoid costly fines, prevent penalties, and steer clear of legal issues.

Common Mistakes Business Owners Make When Paying Themselves

Take care to avoid the following “gotchas” that can result in fines, penalties, loss of personal liability protection, and even suspension of your business operations:

• Mixing personal and business finances.
• Taking excessive owner draws that strain cash flow.
• Not making quarterly estimated tax payments.
• Failing to pay yourself a reasonable salary as a shareholder of an S Corporation.
• Paying yourself an excessive salary as a shareholder of a C Corporation.
• Starting payroll before completing the required payroll tax registrations.

The Bottom Line

How you pay yourself isn’t just an administrative decision—it affects your taxes, compliance obligations, and cash flow.

As your business grows, your compensation strategy may change as well. What works for a sole proprietor may not be the most tax-efficient approach for an established LLC or corporation.

Before making changes to your compensation or tax election, consult your accountant or tax advisor to ensure your approach aligns with your business goals and current tax laws.