I get this question more than almost any other on AskLoral.com. “How do I pay myself? How do I pay my kids?” Business owners ask it like there’s a formula they’re missing. There is, but it’s not what most of them think.
A tax-efficient salary meets the IRS’s reasonable compensation standard while leaving room for distributions that carry a lighter tax load. That’s the technical definition. The real definition is simpler: pay yourself correctly, not casually. Most of you are doing the second one. That’s the mistake.
The principle running through everything I teach is this. Companies make the money and get the deductions. You get taxed. The less you move into your personal bank account, the better off you are. Every dollar that sits in the company instead of your checking account is a dollar working through 300 deductible expenses instead of zero.
“The goal is to pay yourself correctly, not just comfortably or casually.”
Why How You Pay Yourself Matters So Much
Every entity carries a different weight. In an LLC, you’ve got a manager and a member, and you might take a distribution, or you might be employed there. It depends entirely on how the company is structured and how it’s taxed. An S corp lets you split income between salary and distributions, which sounds great until you realize distributions become just another taxable event as you grow.
Here’s the part nobody tells you. If you want a loan or you want health insurance, you have to show your entire S corporation’s income, not just your salary. If your S corp makes a million dollars, that million dollars shows up on your health insurance application. I pay myself a $42,000 salary. My daughter and I have excellent health care because my coverage is based on that $42,000, not on everything my S corp or my LLC generates.
I’m a high revenue earner. I’m not going to call myself a high-income earner because those are two different things. I create a lot of revenue. I only pay myself $42,000 of it because my companies are structured to take the deductions and pay most of my bills. I don’t pay for a phone. I don’t pay for a vehicle. I don’t pay for an office. The companies pay. The better your structure, the better your deduction structure.
What Happens When You Get Your Salary Wrong
Two mistakes show up constantly.
The first is paying yourself too much because you don’t know how to fund the company any other way. When a business is new and not yet generating enough to cover its bills and deductions, you have two real options. You loan the company the money, which it repays once it’s profitable, or you fund it as shareholder equity. Either way, you’re building the company up properly instead of starving it by pulling money out.
The second mistake is taking income through an owner draw rather than a structured distribution. That decision quietly wrecks your balance sheet, and most owners never connect the cause to the effect because they don’t have a real bookkeeper walking them through it.
When you pay yourself too much, you get overtaxed immediately. A W-2 paycheck triggers tax the moment it hits your account, and you live on whatever’s left. The smarter move is to keep money inside the company as long as possible so it can run through the deductions before tax touches it at the very last point.
There’s also a structural mistake I see constantly in construction. The owner runs payroll through the same system as every subcontractor, which forces all benefits and salary levels to align with the crew. Separate the owner’s compensation into its own entity, and the whole picture changes.
“Don’t go off and do something crazy just because you watched a 10-minute video on how to set this up.”
How to Structure Your Compensation the Right Way
This is not a decision you make alone. It’s a decision a tax strategist makes with you, reviewed quarterly, in accordance with the IRS code and your industry’s norms.
You do have to pay yourself reasonably. If you’re a doctor, getting your salary down to the $100,000 to $105,000 range can qualify you for a Roth, among other benefits, even while your business generates far more. The objection I hear every time is some version of “but I have a big lifestyle.” That’s fine. The answer isn’t a bigger salary. The answer lies in how that lifestyle is maintained. Is the house in your name or the company’s? Can you structure housing, travel, technical, or vehicle allowances through the entity rather than payroll? Yes, every time.
In The Millionaire Maker, I teach that most CPAs are historians. They record what has already happened. They don’t forecast what should happen next. A tax strategist forecasts. That distinction alone is worth tens of thousands of dollars a year to a business owner who’s never had anyone do it for them.
Start Today
- Pull your last three pay stubs and your company’s profit and loss. If your personal salary is climbing in line with company revenue instead of staying flat against the deduction strategy, that’s your first red flag.
- Ask your bookkeeper whether you’re taking an owner draw or a structured distribution. If they can’t answer clearly, that’s a sign you need a better bookkeeper before you need a better salary.
- Find a tax strategist who reviews compensation quarterly, not once a year at filing time. Reasonable compensation isn’t a number you set once. It moves with your revenue and your industry.
The math on waiting is brutal. Every $10,000 a year you casually overpay the IRS, invested instead at 12 to 13 percent over twenty years, is $1.1 million you handed away instead of put to work in real estate, oil and gas, or your own assets. You’re designed to become a millionaire in three to five years. A casual salary is how you talk yourself out of it one paycheck at a time.
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