One of the first questions new business owners ask is also one of the most confusing: “How do I pay myself?” If you’ve started bringing in money from your hustle, side gig, or full-blown business, congratulations—that’s a big milestone. But how you take money out of your business can have a big impact on your taxes, your legal risk, and even your financial stability.
It might be tempting to treat your business account like a second wallet. But doing so without a plan can trigger IRS headaches, bookkeeping chaos, and even legal trouble if your business structure doesn’t support it. Whether you’re a solo freelancer or growing a small team, there’s a right way—and a wrong way—to pay yourself.
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Why Paying Yourself Properly Matters
Taking money out of your business the wrong way isn’t just risky—it can cause long-term problems for your taxes, financial planning, and even business credibility. The IRS expects you to play by certain rules depending on your business structure, and not following them can lead to audits or penalties.
Key Reasons to Get It Right
- Tax compliance: Avoid unexpected tax bills or IRS penalties.
- Financial clarity: Know exactly how much your business is making versus what you’re earning personally.
- Professionalism: Look legitimate to lenders, clients, and future partners.
- Scalability: Build systems now that make it easier to grow later.
Let’s break down how to approach this depending on how your business is set up—and how the right business structure can simplify everything.
Paying Yourself as a Sole Proprietor
If you’re operating as a sole proprietor, you and your business are legally the same entity. There’s no legal separation between your personal finances and your business finances. That means you can pay yourself by simply transferring money from your business account to your personal one. It’s called an owner’s draw.
The Catch?
- You still owe self-employment taxes on your business profits, even if you leave the money in the business.
- You’re responsible for tracking everything manually—no W-2, no payroll system.
- You may accidentally overspend if you don’t budget correctly between business and personal needs.
This method works for very small businesses, but as your income grows, so does your risk of errors, inefficiency, and tax issues.
Paying Yourself Through an LLC
Forming an LLC gives you more structure, flexibility, and protection—but the way you pay yourself depends on how your LLC is taxed. By default, a single-member LLC is taxed like a sole proprietorship. But you can also elect to have your LLC taxed as an S corporation, which opens up different options.
Default LLC (Taxed as Sole Proprietor)
- Take an owner’s draw, just like with a sole proprietorship.
- You still report business income and pay self-employment taxes.
- No need for formal payroll, but you should still keep personal and business accounts separate.
LLC Taxed as S Corporation
This is where things get more sophisticated. You must pay yourself a “reasonable salary” through payroll, and you can also take distributions (profit withdrawals) that are not subject to self-employment tax.
- Salary: You pay yourself via payroll like any employee, with taxes withheld.
- Distributions: Additional income you take out as an owner—often taxed at a lower rate.
Many small business owners switch to an S corp setup once their profits hit around $50,000–$75,000 annually, because the tax savings on distributions can be significant.
Separating Business and Personal Finances
No matter your structure, one golden rule applies: Separate your business and personal money. This means having a business bank account, a business credit or debit card, and accounting software (or at least a good spreadsheet) to track everything.
Why This Matters
- Clean records make tax prep easier and more accurate.
- It protects you in case of an audit.
- Helps you truly understand your business’s financial health.
Plus, if your business is an LLC or corporation, mingling funds can “pierce the corporate veil”—meaning courts could ignore your liability protection in a lawsuit. That’s a huge risk and one that’s easily avoidable with good habits.
Understanding Taxes on What You Pay Yourself
This is where things get tricky. Just because you pay yourself doesn’t mean the IRS treats that money the same way in every case. Here’s a simple breakdown:
Tax Implications by Structure
- Sole proprietor or single-member LLC: You pay self-employment tax (15.3%) and income tax on all business profit, regardless of how much you actually draw.
- LLC taxed as S corp: You pay income tax and employment taxes on your salary. Distributions are only subject to income tax, which can lower your overall tax bill.
- Corporation (C corp): Salaries are taxed as regular W-2 wages. Dividends are taxed again on your personal return, so this setup is less common for small businesses unless there are specific reasons.
It’s wise to work with an accountant as soon as your business income starts to grow consistently. They can help you choose the right structure and pay strategy based on your unique goals.
Why Forming an LLC Makes This All Easier
If you’re currently running your business under your own name without any formal structure, forming an LLC can bring clarity and control to how you pay yourself.
Key Benefits of Paying Yourself Through an LLC
- Limited liability: Protects your personal assets if your business faces legal trouble or debt.
- More options: Gives you the ability to elect S corp taxation and save on self-employment taxes.
- Professionalism: Makes it easier to open a business bank account and appear legitimate to clients and lenders.
- Financial discipline: Encourages proper payroll systems, budgeting, and planning.
With an LLC, you’re treating your business like a real business—not just a cash-flowing hobby. That mindset shift alone is worth its weight in tax savings and peace of mind.
Paying yourself should feel like a reward for your hard work—not a source of stress or confusion. The key is understanding your business structure, separating your finances, and choosing the payment method that fits your situation and goals.
For many entrepreneurs, forming an LLC is the first big step toward financial clarity and control. It simplifies your payment process, protects your personal assets, and opens up new opportunities for tax efficiency. Whether you’re drawing a few hundred dollars a month or managing six-figure revenue, the right system for paying yourself will support your growth instead of sabotaging it.
After all, you didn’t build your business just to get tripped up on payroll. You built it to succeed. And success starts with paying yourself the right way.
