For a single-member LLC taxed as a sole proprietorship (the default), you pay yourself through an owner's draw, you simply transfer money from the business account to your personal account. There is no payroll, no W-2, and no withholding. Instead, you pay self-employment tax (15.3%) plus income tax on the entire net profit of the business when you file your annual return, regardless of how much you actually drew out.
For an LLC taxed as an S-Corp, the rules change significantly. You are required to pay yourself a reasonable salary through payroll, subject to payroll taxes, and any additional profit above that salary can be taken as a distribution, which is not subject to self-employment tax. This is the fundamental mechanism behind the S-Corp tax savings strategy.
Confusing Draws With Salary After an S-Corp Election
Consider a business owner who elects S-Corp status on the advice of a tax preparer, specifically to reduce self-employment tax, but continues taking money out of the business the same way they always had, as simple transfers to their personal account, without ever actually setting up payroll. A year later, filing the S-Corp return, it becomes clear no W-2 was ever issued and no payroll taxes were ever withheld or deposited, despite $80,000 having been transferred to the owner over the year.
The IRS, upon review, reclassifies the entire $80,000 as wages retroactively, since no formal salary-versus-distribution structure was ever actually implemented, assessing back payroll taxes, penalties for the missed deposits, and interest, essentially erasing the entire tax benefit the S-Corp election was meant to provide, plus adding real cost on top. The election itself was the right move; the failure to actually run payroll to support it undid the whole strategy.
For a multi-member LLC taxed as a partnership, members take guaranteed payments (similar to salary, taxed as self-employment income) or distributions of profit. The LLC itself does not pay income tax, profits and losses flow through to each member's personal return via a Schedule K-1.
The most common mistake: LLC owners who elected S-Corp status but are not running payroll, or are paying themselves a below-market salary to minimize payroll taxes. Both are red flags for an IRS audit, and both carry penalties that wipe out the tax savings that motivated the election in the first place.
Getting the owner compensation structure right is one of the first things Hasco Tax Advisors reviews for any new business client, because mistakes made in year one often take years to unwind.
Why Draws Aren't Deductible, But Salary Is
A common point of confusion: an owner's draw from a sole-proprietorship-taxed LLC is not a deductible business expense, it doesn't reduce the business's taxable profit at all, since you're taxed on the full net profit regardless of how much you actually draw out. A salary paid through an S-Corp election, by contrast, genuinely is a deductible business expense on the corporate return, which is part of why the salary/distribution split changes the tax math so meaningfully compared to a simple draw structure.
Understanding this distinction, that a draw is simply moving already-taxed profit, while a salary is an actual payroll expense that reduces what the business reports as taxable, is central to understanding why the S-Corp election changes the calculation at all.
Whichever structure applies to you, it's worth keeping owner compensation completely separate from other business transactions in your bookkeeping, tagged clearly rather than lumped in with regular vendor payments or operating expenses. This makes year-end tax preparation considerably faster and gives you a clear, ongoing view of exactly how much you've actually taken from the business at any point in the year.