Owner's Draw vs. Salary: How to Pay Yourself as a Business Owner (2024)

by Ali Hanckel on Apr 6, 2023 4:06:25 PM

As a small business owner, you have the ability to take money out of your business - sometimes referred to as an 'owner's draw.' This can be a great way to ensure that you are financially set for the future and rewards yourself for all of your hard work. However, it is important to understand the difference between an owner's draw and salary when it comes to paying yourself. In this guide, we'll discuss how each payment type works and the advantages and disadvantages that come with them. Knowing exactly what’s involved will help make sure you have secure financial footing both now and down the road.

What is an Owner’s Draw, and How Does It Compare to a Salary?

An owner's draw is a method for business owners to withdraw funds from their business for personal use. It is essentially a distribution of profits to the owner(s) of a business.

Unlike a salary, a fixed amount paid to an employee regularly, an owner's draw is not guaranteed and can vary depending on the business's profitability. Owners may choose to take a draw periodically or only as needed.

Another critical difference between an owner's draw and a salary is that a draw is not subject to payroll taxes, such as Social Security and Medicare. This can result in tax savings for the owner. However, owners are still responsible for paying income taxes on their draw as it is considered personal income.

It's important to note that not all businesses can take owner's draws. Only certain types of business structures, such as sole proprietorships, partnerships, and LLCs, allow owners to take draws. In contrast, owners of corporations typically receive salaries and may also receive dividends on their shares of stock.

Overall, the decision to take an owner's draw versus a salary depends on the specific circ*mstances of the business and the preferences of the owner. It's essential to consult with a financial professional to determine the best course of action for your situation.

When is it Better to Take a Salary Instead of an Owner's Draw?

The decision to take a salary or an owner's draw depends on the specific circ*mstances of your business and your financial situation. Here are some factors to consider when making this decision:

Legal Structure

The legal structure of your business can impact your ability to take an owner's draw. For example, if you operate as a sole proprietorship or partnership, you may be able to take an owner's draw, but if you operate as a corporation, you may need to take a salary.

Tax Implications

The way you are taxed on your income can also influence whether you choose to take a salary or an owner's draw. Depending on the structure of your business, taking a salary may result in more taxes being withheld at the source, whereas taking an owner's draw may require you to pay estimated taxes.

Cash Flow

If your business has limited cash flow, a salary may be the better option since it guarantees a consistent income. On the other hand, if your business has surplus cash flow, you may be able to take an owner's draw without impacting your ability to pay bills and other expenses.

Personal Financial Needs

Your financial situation can also impact your decision to take a salary or an owner's draw. If you need a steady income to pay private bills, a salary may be a better option. If you have more flexibility in your finances, an owner's draw may provide more financial benefits.

Future Plans

Finally, consider your plans for the business. If you plan to sell the business or take on investors, a salary may be a better option since it provides a more stable income stream. However, if you plan to keep the business long-term, an owner's draw may be a more attractive option.

Ultimately, the decision to take a salary or an owner's draw should be based on your circ*mstances and financial goals. It is always a good idea to consult with a financial advisor or tax professional before making major financial decisions.

Advantages & Disadvantages of an Owner's Draw Compared to Salaries

An owner's draw and a salary are two methods of compensating business owners for their work in a company. Each method has advantages and disadvantages, and the choice between the two depends on various factors, such as the business structure, cash flow, tax implications, and personal financial needs. Here are some of the advantages and disadvantages of an owner's draw compared to a salary:

Advantages of an Owner's Draw

Tax Advantages

An owner's draw is usually not subject to payroll taxes, which can result in lower overall tax liabilities for the business owner.

Flexibility

An owner's draw provides more flexibility in terms of the timing and amount of compensation. The owner can take money from the business without setting a fixed salary.

No Withholdings

An owner's draw is not subject to mandatory withholdings, which means the business owner can take out as much or as little money as they need without worrying about deductions for taxes, retirement plans, or other benefits.

Ownership

An owner's draw does not affect the owner's equity in the business. The owner remains the business's sole owner regardless of how much money they take out.

Disadvantages of an Owner's Draw

Uncertainty

An owner's draw can be uncertain as it depends on the company's profitability and cash flow. If the company's revenue decreases, there may not be enough money available for the owner to take a draw.

Lack of Stability

An owner's draw does not provide a fixed income stream, which may make it difficult for the owner to plan their finances.

Related Reading: 5 Financial Accounts to Help Manage Your Business Finances

Less Credibility

An owner's draw may be less credible to lenders or investors than a fixed salary, which could negatively impact the business's ability to secure financing or attract investment.

Advantages of a Salary

Consistency

A salary provides a consistent income stream, making it easier for the owner to plan personal finances.

Tax Withholdings

A salary is subject to payroll taxes, but this can be advantageous for some business owners as the taxes are withheld at the source, eliminating the need to pay estimated taxes quarterly.

Credibility

A salary may be more credible to lenders and investors, which can help the business secure financing or investment.

Disadvantages of a Salary:

Tax Disadvantages

A salary is subject to payroll taxes, which can increase the overall tax liabilities of the business owner.

Less Flexibility

A salary provides less flexibility than an owner's draw. The owner must set a fixed salary, which may be challenging if the business has unpredictable cash flows.

Equity

A salary can impact the owner's equity in the business, as it may be viewed as an expense that reduces the company's profitability.

Overall, the choice between an owner's draw and a salary depends on the specific circ*mstances of the business and the owner's personal financial needs. It is essential to consider the advantages and disadvantages of both methods before making a decision.

How to Utilize an Owner's Draw for Tax Savings & Capital Growth

An owner's draw is a method of withdrawing funds from a business structured as a sole proprietorship, partnership, or limited liability company (LLC). Here are some ways to utilize an owner's draw for tax savings and capital growth:

Reduce taxable income

An owner's draw is not taxable income for the business owner since it is a withdrawal of the owner's equity in the business. Therefore, taking an owner's draw instead of a salary can reduce the amount of taxable income for the business.

Plan for quarterly taxes

Since an owner's draw is not subject to payroll taxes, it is essential to plan for quarterly estimated tax payments to ensure that the appropriate amount of taxes are paid throughout the year.

Reinvest the money

Instead of spending the owner's draw on personal expenses, consider reinvesting the funds into the business. This can help to grow the business and increase its value over time.

Invest in retirement accounts

Owners of small businesses can take advantage of retirement accounts such as a Simplified Employee Pension (SEP) IRA or a Solo 401(k) plan. Contributing a portion of the owner's draw to these accounts can provide tax benefits and help to grow retirement savings.

Consult with a tax professional

It is essential to consult with a tax professional to determine the best way to utilize an owner's draw for tax savings and capital growth. A tax professional can provide advice on tax planning strategies and ensure that the business owner is compliant with tax laws and regulations.

What Strategies Can be Used to Maximize the Benefits of an Owner’s Draw?

Maximizing the benefits of an owner's draw involves careful planning and execution. Here are some strategies that can help maximize the benefits of an owner's interest:

Establish a Budget: To maximize the benefits of an owner's draw, it is essential to establish and stick to a budget. This will help ensure that the business has the sufficient cash flow to cover its expenses while allowing the owner to take a draw.

Monitor Cash Flow: It is crucial to monitor the business's cash flow regularly to determine the amount of money available for an owner's draw. This will help avoid taking out too much money that the company cannot afford to spare.

Consider Tax Implications: While an owner's draw can provide tax advantages, it is essential to consult with a tax professional to determine the optimal amount to take out. Taking out too much money could result in higher tax liabilities.

Be Consistent: To maximize the benefits of an owner's draw, it is essential to be consistent in the amount and timing of the draw. This will help establish a reliable income stream for the owner and allow for better personal financial planning.

Reinvest in the Business: To ensure long-term success, it is important to reinvest in the business. This could involve using some of the owner's draw to finance new projects or equipment or to hire additional staff to increase revenue.

Plan for the Future: When taking an owner's draw, it is essential to plan for the future of the business. This could include setting aside some draws for unexpected expenses or preparing for future growth.

Consider Business Structure: The business structure can impact the owner's ability to take an owner's draw. It is essential to consult with a financial professional to determine the best structure for the business to maximize the benefits of an owner's draw.

Maximizing the benefits of an owner's draw involves careful planning and execution. By establishing a budget, monitoring cash flow, considering tax implications, being consistent, reinvesting in the business, planning for the future, and considering the business structure, business owners can maximize the benefits of an owner's draw while ensuring the long-term success of the business.

FAQs

Owner's Draw vs. Salary: How to Pay Yourself as a Business Owner? ›

Is it better to take a draw or salary? The answer is “it depends” as both have pros and cons. An owner's draw provides more flexibility — instead of paying yourself a fixed amount, your pay can be adjusted based on how well the business is doing or based on how much money you need.

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Is it better to take an owners draw or salary? ›

The owner's draw method offers greater flexibility than the salary method. Draws can be tied directly to your business's performance and taken as frequently or infrequently as necessary. One disadvantage of the owner's draw method is that taxes are not deducted until the end of the year.

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How should I pay myself as a business owner? ›

Business owners can pay themselves through a draw, a salary, or a combination method:

A draw is a direct payment from the business to yourself.
A salary goes through the payroll process and taxes are withheld.
A combination method means you take part of your income as salary and part of it as a draw or distribution.

Oct 27, 2023

Is it better to take distributions or salary? ›

Benefits of Paying Distributions

Those owners taking a wage will pay half of the 15.3% of their salaries. The half paid by the company will also be a write-off as it goes against overall profits. Any amount given as a distribution above the owner's salary will not be subject to employment taxes.

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What is the most tax-efficient way to pay yourself? ›

For tax efficiency, most company directors will choose to pay themselves a low salary and take any further money from the company in the form of dividends. This is because dividends are taxed at a lower rate than salary, and avoid national insurance contributions.

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What percentage should owners pay themselves? ›

What Percentage Of Your Income Should You Pay Yourself First? As a business owner, determining how much of your income to set aside can be a bit more complex than if you were an employee. However, 10%-15% of your income is generally a good rule of thumb.

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What percentage should I pay myself from my LLC? ›

Some tax professionals recommend paying yourself 60 percent in salary and 40 percent in dividends to stay clear of IRS problems unless this means your salary would be too low compared to others in your field.

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What is the best way to pay yourself as an S Corp owner? ›

A commonly touted strategy to set your S Corp salary is to split revenue between your salary and distributions — 60% as salary, 40% as distributions. Another common rule, dubbed the S Corp Salary 50/50 Rule is even simpler, with 50% of the business income paid in salary and 50% in profit distribution.

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Can the owner of an LLC pay himself through payroll? ›

If you choose to pay yourself a salary from your LLC as an employee, you will pay income tax on your wages earned, and the LLC must file a W-2 form to show the IRS your payments and withheld taxes. You'll need to file IRS Form W-4 to determine the amount of income tax that the LLC should withhold from your paychecks.

What is the 60 40 rule for S Corp salary? ›

What is the 60/40 rule? The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.

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How are owner draws taxed in LLC? ›

Draws and distributions both have tax implications. The distribution or draw itself is not a taxable event. The owner pays income tax on the profit reported at the end of the year which would cover all distributions or draws. Draws are also subject to self employment tax.

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Are owner drawings tax deductible? ›

From a business perspective, an owner's draw is not a tax-deductible expense and hence should not be listed on your company's Schedule C. Salaries, however, are tax-deductible. From an individual's perspective, owner's draws are not usually taxed at source in the same way as salaries.

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How to transfer money from LLC to personal account? ›

That's called an owner's draw. You can simply write yourself a check or transfer the money for your business profits from your LLC's business bank account to your personal bank account.

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Do I pay income tax on owners' draws? ›

Owner's draw is considered taxable income, whether you're a sole proprietor, partner, or part of an LLC.

Does owners draw reduce profit? ›

The Owner's Draw Method

No taxes are withheld from the check since an owner's draw is considered a removal of profits and not personal income.

Should I take more salary or equity? ›

The main advantage of equity

Equity supplements your salary package with deferred, but potentially significant compensation, even more so if you join a company that is just starting up and that takes off later down the line. The younger the company, the more money its equity could end up representing.

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Is it better to be self-employed or on payroll? ›

On average, freelancers earn 45% more than those who are traditionally employed. They're also allowed to deduct certain business expenses that employees are not, allowing to actually keep more of what they earn. Feel like you're not quite there yet? Check out my 7 Tips for Negotiating High End Rates.