How To Pay Yourself: Owner’s Draw vs Payroll
You’re building a business, not a guessing game. Getting paid is simple when you match the method to your entity and run a clean system. Get it wrong and you invite penalties, messy books, and lender headaches. Get it right and your taxes drop, your cash gets predictable, and your stress level falls. I’m going to break this down in plain English, with concrete steps you can run this week.
Key truth. If you don’t have enough tax withheld from a paycheck, you are expected to make quarterly estimated payments. That includes sole proprietors, partners, and S corporation shareholders. The IRS spells out who must pay and the due dates. IRS+1
First principles: your entity decides the path
Sole proprietorship and single-member LLC taxed as sole prop
You do not put yourself on payroll. You take owner’s draws from profits.
Draws are not wages. There is no withholding on the draw itself. You still owe income tax and self-employment tax and you handle that through quarterly estimates. The IRS makes this clear in its guidance for self-employed individuals and estimated tax rules. IRS+1
A single-member LLC that is a disregarded entity is treated like a sole prop for federal tax purposes unless it elects corporate taxation. IRS
Partnership or multi-member LLC taxed as a partnership
Partners are not W-2 employees. Do not issue yourself a W-2 for partnership distributions or guaranteed payments. The IRS says this explicitly. IRS
You may receive guaranteed payments for services or capital and you may receive distributive shares of profit. Guaranteed payments are ordinary income to you. The partnership rules cover the difference. IRS
You handle taxes via quarterly estimates on your personal return, based on K-1 income. IRS
S corporation
If you work in the business, the IRS expects a reasonable W-2 salary before you take any distributions. Not optional. Paying shareholder-employees appropriately is a core S corp rule. IRS+1
After you pay yourself a reasonable salary, you can take distributions of profit. Those are not subject to payroll tax, but you must get the salary right first. IRS
C corporation
The corporation is a separate taxpayer. Owner-operators are paid as W-2 employees if they work in the business. Employment tax and withholding rules apply like any other employee. The IRS employer guidance governs how withholding and deposits work. IRS+1
Owner’s draw vs payroll: plain-English tradeoffs
Owner’s draw
Simple and flexible. Pull cash when profits allow.
No payroll filings on the draw itself. You still owe income tax and self-employment tax via quarterly estimates if you expect to owe at least 1,000 dollars. IRS
Works for sole props and partners. Do not use draws alone if you are an S corp owner-operator.
Payroll
Predictable paychecks on a schedule.
Wages require proper withholding, deposits, and quarterly employer returns. Publication 15 is your rulebook for federal employment tax responsibilities. IRS
Required for S corp owner-operators who perform services. Reasonable compensation first, then distributions. IRS
What “reasonable compensation” really means for S corps
Reasonable compensation is what you would pay someone else to do your job at your company. The IRS looks at your duties, training, time spent, what similar roles pay, and whether revenue comes from your services, other employees, or capital. If you work in the business and take large distributions with little or no W-2 wage, you are inviting scrutiny. Start with a real number and document how you arrived at it. The IRS provides direct guidance on S corporation employees and points to reasonable compensation issues. IRS
The quarterly tax reality you can’t ignore
If you do not have enough withholding from a paycheck, you pay as you go.
Individuals who expect to owe 1,000 dollars or more generally must make estimated tax payments.
Calendar-year due dates are typically April 15, June 15, September 15, and January 15 of the next year. The IRS publishes the grid and exceptions. Automate these dates. IRS+1
Payroll 101 for owner-operators
If you pay yourself wages, you must withhold and deposit correctly.
Federal income tax, Social Security, and Medicare must be withheld and deposited on a monthly or semiweekly schedule depending on your lookback period. Topic 757 explains the deposit schedules. IRS
The IRS employer calendar shows deposit timing. Publication 15 summarizes responsibilities and points to Pub 15-T for withholding tables. IRS+1
Keep it boring. Pick a payroll cadence. Automate deposits. File on time.
How I coach owners by entity
If you are a sole prop or single-member LLC taxed as a sole prop
Set a fixed draw schedule. Pay yourself the 1st and 15th.
Create a weekly tax sweep. Move a percent of revenue into a separate tax account every Friday.
Estimate quarterly. Use year-to-date profit to update estimates so you avoid underpayment penalties. The IRS provides the who-must-pay rules and due dates. IRS+1
Reimburse the right way. If you pay business expenses personally, use an accountable plan and submit receipts so reimbursements stay tax-free. The IRS explains that nonaccountable allowances become taxable wages. IRS
If you are in a partnership
Stop issuing yourself W-2s. Partners are not employees. Use guaranteed payments and distributions as the law allows. IRS+1
Document guaranteed payments. Write down what they are for and when they are paid.
Make estimates. Base them on K-1 income and guaranteed payments. IRS
Reimburse correctly. Use an accountable plan so partner reimbursements are not taxed as wages by mistake. Rev. Rul. 2003-106 and IRS guidance support accountable treatment when properly substantiated. IRS
If you are an S corporation owner-operator
Set your salary first. Document the role, duties, hours, and market data that support your number. The IRS expects reasonable W-2 wages. IRS
Pick a clean cadence. Pay biweekly or twice monthly. Consistency is your friend.
Layer distributions. Once per quarter, distribute profit after funding taxes and working capital.
Follow payroll rules. Withhold, deposit, and file using Publication 15 as your guide. IRS
Adjust midyear. If profit rises, revisit your salary. Document the change and why.
If you are a C corporation owner-operator
Treat yourself like any other employee. W-2 wages, proper withholding, proper deposits. Follow Publication 15. IRS
Be thoughtful with dividends. Wages are compensation. Dividends are distributions of profit and follow different tax rules. Do not confuse the two.
Decision tree: choose draws, payroll, or both
Are you a sole prop or partnership? Use draws. Make estimated payments each quarter. IRS
Are you an S corp owner who works in the business? Pay a reasonable salary first. Then take distributions. IRS
Do you want predictable household cash flow? Payroll helps because checks are consistent.
Do you want to reduce surprises and penalties? Automate a weekly tax sweep and the four estimate dates. IRS
Common red flags that trigger headaches
S corp taking big distributions with little or no W-2 wages. This is an audit magnet. The IRS has been explicit about the wage requirement. IRS
Partners getting W-2s. Partners are not employees. Use the right tools. IRS
No estimated payments. If you expect to owe 1,000 dollars or more and never schedule estimates, penalties pile up. IRS
Nonaccountable reimbursements. Flat allowances without receipts are taxable wages. Fix it with an accountable plan. IRS
The paycheck formula I give S corp owners
You want a number that is fair, defensible, and cash-flow friendly.
Define the role. List your core functions and hours per week.
Find market data. Use your industry’s pay data for similar roles in your city.
Adjust for company dependence. If revenue is driven by your personal services, lean higher. If revenue is mostly from employees or capital, note that in your file. These are factors the IRS cares about under reasonable compensation. IRS
Pick the base. Set a W-2 salary at the low end of defensible.
Set distributions quarterly. After funding taxes and reserves, distribute remaining profit in larger, intentional chunks.
Revisit twice a year. If profit or your role changes, update your number and the memo that supports it.
Document this in a one-page “Owner Pay Policy.” Keep it with your corporate records.
The “boring but rich” monthly close for everyone
Thirty to sixty minutes once a month saves you hours in April.
Reconcile every bank and credit card.
Categorize every transaction.
Attach receipts to travel, meals, and mileage logs.
Separate and tag owner draws, distributions, or wages so they do not get misclassified.
Update year-to-date profit and adjust estimates. The IRS dates are fixed. Your payment plan should be too. IRS
Step-by-step setup you can finish this week
1) Choose your pay method by entity.
Write it down. Sole prop and partners use draws. S corp and C corp owner-operators use payroll. Back this with the IRS pages noted above. IRS+1
2) Open a separate tax reserve account.
Automate a weekly sweep. I like 20 to 30 percent of gross receipts as a default starting point. Adjust once you have a projection.
3) Put the four estimate dates on your calendar and invite your bookkeeper.
April 15. June 15. September 15. January 15. The IRS posts these deadlines every year. IRS
4) If you need payroll, stand it up fast.
File your state registrations, pick a payroll provider, and align with Publication 15 for responsibilities and the 941 deposit schedule rules. IRS+1
5) Build an accountable plan.
One page. What you will reimburse, how to submit, and when. Keep receipts. IRS guidance shows that allowances without substantiation are wages. IRS
6) Draft your Owner Pay Policy.
State your entity, your method, your pay dates, your distribution cadence, and where you store support for reasonable compensation if you are an S corp. Keep it simple.
7) Run a quick tax projection.
Use your year-to-date profit to check whether you need to increase your weekly tax sweep or your payroll withholding. If you expect to owe 1,000 dollars or more, set the estimate. IRS
Examples you can copy
Sole prop example
Draw 2 fixed amounts on the 1st and 15th.
Sweep 25 percent of weekly revenue into the tax account.
On the first Tuesday each month, reconcile, update profit, and adjust the next estimate.
Partnership example
Pay a monthly guaranteed payment for your agreed services. Track it in the partnership agreement. IRS
Distribute profits quarterly if cash allows.
Make personal estimates based on K-1 projections. IRS
S corp example
W-2 salary paid twice monthly. Start at a defensible market number. IRS
Quarterly distributions after tax reserve and working capital are funded.
Review salary midyear if your role or profits change.
C corp example
W-2 salary on a regular cadence. Deposit and file as required. Follow the employer’s guide. IRS
Dividends are a separate decision from wages. Do not mix. Keep minutes for each decision.
Quick FAQ
Can I pay myself both a salary and draws?
If you are an S corp owner-operator, pay salary first, then take distributions of profit. A draw alone without wages is a red flag. IRS
If you are a sole prop or partner, you do not put yourself on W-2 payroll, so you use draws. IRS
Do I need to make estimated payments if I am on payroll?
Maybe. If your payroll withholding does not cover your total annual tax, schedule estimates for the difference. The IRS explains who must pay. IRS
How often should I change my pay?
Not weekly. Set a number you can defend and revisit twice a year or when your role and profits meaningfully change.
What if I already paid myself the wrong way?
Fix it going forward. Reclassify as needed with your CPA. Build the Owner Pay Policy and follow it.
Resource links
IRS: Paying yourself. Entity by entity guidance, including the rule that partners are not employees and W-2s are not appropriate for partnership payments. IRS
IRS: Publication 15, Employer’s Tax Guide. Withholding, depositing, and filing responsibilities for employers running payroll. IRS
Bottom line
This is about clarity and discipline. Your entity decides your pay method. Sole props and partners use draws and pay estimates. S corp and C corp owner-operators use payroll. Set a weekly tax sweep. Put the four estimate dates on the calendar. If you are an S corp, set a real salary you can defend and pay it on schedule. Keep reimbursements accountable and your monthly close boring.
If you want me to run your numbers and build this system with you, book a Black Mammoth Power Hour. We will set your salary, your draws, your tax sweeps, and your calendar in one working session.