Salary vs Owners Draw: How Much To Take of Each

If you’re a small business owner in California, paying yourself the wrong way can quietly cost you thousands in self-employment income taxes, trigger tax compliance issues, or create avoidable scrutiny from the IRS and Franchise Tax Board. The right answer depends on your business structure.

Here’s the short version upfront:

• Owner draw is common for small businesses structured as a sole proprietorship, partnership, or default-taxed limited liability company
• Owner salary is required for S Corp shareholders and common in a C Corp
• Choosing incorrectly can lead to IRS penalties, payroll tax issues, and FTB headaches

Let’s break it down properly.

What Is an Owner’s Draw?

An owner’s draw is when you take money out of the business account for personal use without running payroll.

Key characteristics:

• Not a business expense
• No payroll taxes withheld at the time of payment
• Doesn’t reduce taxable profit directly
• Taken from owner’s equity, not wages

This is how most sole proprietors, partnerships, and default-taxed LLCs pay themselves.

Common misconception

Many California business owners assume owner’s draws are “tax-free.” They aren’t. You’re still taxed on the business’s net profit, regardless of whether you leave the money in the company or withdraw it. The draw only affects cash, not tax liability.

Poor bookkeeping and weak income and expense tracking make this worse, especially when personal expenses are mixed with business activity.

What Is a Salary?

A salary is regular compensation paid through payroll.

Key characteristics:

• Subject to federal income tax withholding
• Subject to Social Security and Medicare
• Requires payroll filings and ongoing tax compliance
• Deductible business expense

In California, this also means:

• State income tax withholding
• EDD payroll filings
• Workers’ comp considerations
• More scrutiny from the Franchise Tax Board

This setup requires a payroll provider and accurate records to avoid missed filings or incorrect remittances.

When salary is mandatory

If you own an S Corporation, the IRS requires you to pay yourself a reasonable owner salary before taking distributions. This compensation must be reported on Form W-2.

This is not optional for S Corp shareholders.

Salary vs Owner’s Draw: Side-by-Side

How Business Structure Changes the Answer

This is where most online advice gets sloppy. Business structures matter.

Sole Proprietorship

• You cannot pay yourself a salary
• Owner draw only
• You pay self-employment income taxes on net profit

Partnership or Multi-Member LLC

• Owner draw or guaranteed payments
• No payroll salary for owners
• Still subject to self-employment tax

Payments to owners are not reported on Form 1099-NEC. Owners are not contractors.

LLC Taxed as an S-Corp

• You must pay yourself a reasonable salary
• Salary reported on Form W-2
• Additional profits can be taken as distributions

This requires filing Form 8832 (entity classification) and Form 2553 (S-Corp election). This structure is often used to reduce self-employment taxes, but only when payroll, bookkeeping, and compliance are done correctly.

C Corporation

• Salary is common and deductible
• Dividends may also be paid
• Different tax planning and tax implications apply

A C Corp introduces double taxation considerations but offers more flexibility in compensation planning.

California-Specific Risks to Watch

California is less forgiving than many states, especially for service-based businesses.

Common problem areas:

• Underpaying yourself in an S-Corp
• Skipping payroll filings or using the wrong payroll provider
• Incorrect EDD reporting
• Mixing owner draws with payroll inconsistently
• Using business funds for personal expenses without proper classification

These issues often surface when income and expense tracking is weak or when the business account isn’t kept separate from personal spending.

Which Option Is Better?

Here’s the blunt answer:

• If you’re not an S-Corp, owner draw is usually correct
• If you are an S-Corp, salary is mandatory
• If you’re guessing, you’re probably doing it wrong

The “best” option depends on:

• Profit level
• Business structure
• Growth plans
• Compliance tolerance
• Long-term tax strategy

Final Takeaway for California Business Owners

Salary vs owner draw isn’t about preference. It’s about structure, tax compliance, and efficiency.

Paying yourself incorrectly can:

• Inflate your tax bill
• Trigger penalties
• Create audit exposure
• Break payroll compliance

Getting it right creates clarity, predictable cash flow, and cleaner financials.

If you’re unsure which method applies to your business or whether your current setup still makes sense, that’s usually the signal to review it now, before the IRS or California does.