Owner's Draw vs Salary

As a business owner, you need to get paid — but the method depends on your business structure. An owner's draw is when you simply take money out of the business as needed. There's no paycheck, no tax withholding, and no fixed schedule. You write yourself a check or transfer money from the business account to your personal account. Draws reduce your equity in the business (specifically, retained earnings or owner's equity on your balance sheet).

A salary, on the other hand, is a fixed amount paid on a regular schedule — just like you'd pay an employee. Taxes are withheld from each paycheck (federal income tax, state income tax, Social Security, Medicare), and the business pays its share of payroll taxes. You get a W-2 at the end of the year.

Which one you use depends on your business structure. Sole proprietors and single-member LLC owners typically take draws — the IRS doesn't require a salary. Partners in a partnership take guaranteed payments (similar to draws) plus their share of profits. But if you've elected S-Corp status, the IRS requires you to pay yourself a "reasonable salary" before taking any additional distributions. This is because salary is subject to FICA taxes (15.3%), while S-Corp distributions are not. The IRS knows the temptation to set a tiny salary and take the rest as distributions to avoid payroll taxes — and they audit for it.

The draw vs. salary decision directly impacts your tax bill, cash flow, and IRS compliance. Sole proprietors who take draws pay self-employment tax (15.3%) on all net business income regardless of how much they actually take out. S-Corp owners who pay themselves a salary only owe FICA on the salary portion — distributions escape FICA taxes. But set the salary too low and you risk an IRS audit and reclassification of distributions as wages (plus penalties and back taxes). Getting this right can save you thousands annually, but getting it wrong can cost you even more.