What should I pay myself? A practical guide for small business owners.
One of the most common (and surprisingly complicated) questions business owners ask is “What should I pay myself?”.
As an entrepreneur, you're not just the boss, you’re also an employee, strategist, investor, and sometimes the janitor. With so many hats, figuring out what to pay yourself can feel unclear or even indulgent. But paying yourself fairly is not only necessary, it’s also a smart financial and tax strategy…. not to mention a requirement by the IRS!
Many owners—especially those in early growth phases—put all profits back into the business. While that may help with growth, not paying yourself long-term isn’t sustainable.
Paying yourself has many benefits. It helps protect personal finances - you need to pay your own bills and plan for your future, set boundaries - separating personal income from business cash flow (which is important for legal protection), create consistency - helping with budgeting, taxes, and business forecasting and most importantly, establishing value - you are performing real work and deserve to be compensated for it!
Your business structure plays a big role in how and how much you pay yourself.
- Sole Proprietors & Single-Member LLCs
You take an owner’s draw (withdrawals) from the business profits. There’s no set “salary,” but you should regularly review profits and allocate a consistent amount. All profits are taxed as personal income, and you pay self-employment tax (Social Security & Medicare) on the net earnings, not on the draw itself. - Partnerships & Multi-Member LLCs
You may receive guaranteed payments and/or take distributions, depending on the partnership agreement. You’ll report your share of profits on your personal tax return and pay self-employment taxes. Like owner’s draw, guaranteed payments should be planned and consistent and do not attract Social Security and Medicare on payment. - C Corporations
Owners must be on payroll and paid a salary. Wages are subject to employment taxes, and dividends (if distributed) are taxed again at the personal level—this is the classic “double taxation” structure. - S-Corporations
This is where the “what should I pay myself” question becomes more than just financial—it’s also a compliance issue. As an S-Corp shareholder who actively works and contributes to the business, you are required to pay yourself a reasonable compensation via W-2 wages before taking any non-wage distributions.
So, what is reasonable compensation?
According to the IRS, “The fair market value of economic benefits received for the performance of services is reasonable compensation, which is the value that would ordinarily be paid for like services by a like enterprise under like circumstances”.
In layman’s terms, what the IRS is saying is that you must pay yourself a similar amount that you would pay someone (not you) to do the same service that you are currently performing in your company. If you need to take emergency leave and must find someone to replace you in the company, how much would hiring such a person cost?
The IRS has acted against S-Corp owners who underpay themselves and if audited, the IRS can reclassify distributions as wages—leading to back payroll taxes, penalties and interest and increased scrutiny. Cases like David E. Watson, P.C. v. U.S. demonstrate that the IRS doesn’t take this lightly.
So how do you decide what to pay yourself?
Firstly, let’s start with your role in the company. What are all the roles that you have in the business?
Secondly, if you must hire someone to fulfil your position, what would it cost? You should use market data and document your sources. You can also do a Reasonable Compensation analysis with a reputable firm.
Thirdly, consider where your business is in its stage of life and what it can afford. While the reasonable compensation analysis might provide a fair market value figure, it does not necessarily mean that that is what your company can afford. The salary chosen must be reasonable but also sustainable for the business. A review of your profits and cash flow would assist in determining what the company can reasonably sustain.
Once you have determined your reasonable salary amount, start paying yourself a Salary! Periodic reviews should be set up so that your compensation can evolve as your business is evolving.
Many business owners struggle with this topic. The reason many of you got into business was for some level of financial freedom but how can you have that if you are not paying yourself!
You are your business’s most valuable player, take care of the business and let the business take care of you. Paying yourself is not selfish, it does not make you a bad person… on the contrary it means that you value yourself and the effort that you put into the business. Paying yourself is strategic. It should give you clarity and confidence in yourself and your abilities while helping you be compliant with the IRS. In the long term, it helps you build a stronger, healthier business.
