By Jarret Willey | Founder, JW Tax & Consulting
How you pull money out of your business is not a bookkeeping detail. It is a tax decision.
A salary, an owner draw, and an S-Corp distribution are not the same thing. Each follows different tax rules. And once the calendar flips past December 31, most of this year’s pay choices are locked.
This post is not about LLC vs S-Corp. It is about how to pay yourself once you have a structure, and what to fix before year-end.
| 15.3% | $184,500 | Reasonable W-2 first |
|---|---|---|
| Self-employment tax rate (12.4% Social Security + 2.9% Medicare) | 2026 Social Security wage base. Earnings above it skip the 12.4% piece | IRS rule: S-Corp owners who work in the business must take reasonable W-2 pay before distributions |
Salary vs Owner Draws vs Distributions
People use these words as if they mean the same thing. They don’t.
Owner draw (sole prop or single-member LLC).
You move money from the business account to yours. It is not a wage and not a deduction. Your tax is based on the business’s net profit, not on what you withdrew. Self-employment tax applies to that profit.
W-2 salary.
You are on payroll. The company withholds tax and pays its share of Social Security and Medicare. The salary is a business expense, and it counts as earned income for retirement contributions.
S-Corp distribution.
Once you pay yourself a reasonable salary, remaining profit can often come out as a distribution. Distributions generally skip Social Security and Medicare tax. That is why the split matters, and why the IRS wants the salary to be real.
If you are still an LLC taking only draws, you don’t get that split. Structure and pay method have to work together.
Why the Split Matters
1. Self-employment tax is expensive
Self-employment tax is 15.3%: 12.4% for Social Security and 2.9% for Medicare (IRS). The Social Security piece stops at the wage base, which is $184,500 for 2026 (SSA). Medicare has no cap.
In an S-Corp, these taxes land mainly on your salary, not on every dollar of profit. That is the lever. It is not a loophole, and it is not permission to pay yourself $1.
2. Reasonable pay is an IRS rule
The IRS is clear: S-Corp owners who work in the business must take reasonable W-2 pay before distributions.
There is no safe formula and no magic percentage. The IRS looks at your duties, your time, and what similar businesses pay. A tiny salary with big distributions is a classic audit target. The IRS can reclassify those distributions as wages and add tax, interest, and penalties.
Reasonable does not mean as low as possible. It means defensible.
3. Payroll runs on the calendar
Wages count in the year they are paid. If your plan calls for $180,000 in 2026 and payroll only ran $90,000 by December 31, the plan didn’t happen. A January bonus is next year’s wage.
What to Fix Before Year-End
Set the salary.
Write down what you do. Check what that role pays in the market. Pick a number you can defend, then run payroll so it lands this year.
Stop treating draws as a strategy.
Draws move cash. They are not a tax plan. In an S-Corp, pay wages first, then distributions.
Get the Solo 401(k) timing right.
If you are a sole proprietor or single-member LLC with no employees, you can set up a new Solo 401(k) for 2026 as late as your 2026 tax return due date, not counting extensions. In that first year, you can still make your employee deferral by that date. If you own an S-Corp, your employee deferrals have to come out of W-2 payroll by December 31, so the plan needs to be in place in time to run them. For 2026, the employee deferral limit is $24,500, and the total limit is $72,000 before catch-up (IRS).
Update your estimates.
A new pay setup changes your quarterly tax payments. Don’t wait until April to find out you underpaid.
Document it.
Keep a short pay memo, payroll reports, and distribution records. If the IRS asks why your salary is what it is, you want the answer written down now.
When to Act
Now through December 31 — Run the plan
Set reasonable pay. Run year-end payroll true-ups. S-Corp owners: get 401(k) deferrals through payroll. Line up distributions with the books.
January — Check W-2s and reset
Confirm W-2s match what you paid. Reset salary if your role or profit changed. Set new estimated payments.
February through April — File on what you built
Sole props and single-member LLCs with no employees: this is the last window to open a first-year Solo 401(k) and make 2026 deferrals, by the filing deadline without extensions. Your preparer can report what you did. They cannot create wages you never paid.
Same Owner, Same Profit — Prep-Only Pay vs Planned Pay
Illustrative example only. Not a projection of your results, and savings are not guaranteed. Uses published 2026 figures. Your state, filing status, and pay facts will change the math.
Prep-only pay — Owner, ~$500K net profit
Sole prop or single-member LLC. Takes draws as needed. No W-2. No salary/distribution split. No owner retirement plan.
Self-employment tax alone (illustrative): roughly $36,000–$39,000, before income tax. Accurate return. Heavy payroll-tax cost. Little sheltered.
Planned pay — Same owner, same ~$500K profit
S-Corp with a reasonable W-2 salary in an illustrative $160,000–$200,000 range. The rest comes out as distributions. A Solo 401(k) is funded from payroll.
Social Security and Medicare apply to the salary: roughly $24,000–$31,000 combined (illustrative). Distributions above that generally skip those taxes. The Solo 401(k) can shelter up to $24,500 in deferrals plus an employer contribution, within the $72,000 total limit.
Same profit. Different pay method. Different result.
The Five-Year Math
Illustrative only: if planned pay improves this owner’s taxes by about $25,000–$45,000 a year, five years comes to roughly $125,000–$225,000 kept instead of paid. Your real number depends on salary, state, and how much retirement room you use.
Ranges, not promises.
❌ Draws-Only Chaos vs ✓ Planned Pay Structure
❌ Draws-Only / Prep-Only
Pull cash whenever the account looks full
No W-2, or a token salary with huge distributions
Self-employment tax on nearly all profit
Reasonable pay undocumented
Retirement deadlines missed
April is when you find out what the year cost
✓ Planned Salary + Distributions
W-2 set to a defensible market rate
Distributions only after reasonable wages
Payroll taxes tied to salary, not all profit
Pay memo and payroll records on file
Solo 401(k) set up in time for your entity type
Year-end payroll done before December 31
Self-Check: Is Your Pay Method Actually a Plan?
Ask yourself honestly:
- Do you know how last year’s money came out: wages, draws, distributions, or a mix?
- If you are an S-Corp, did you take a reasonable salary before distributions, and could you defend it?
- Does this year’s payroll match the salary you meant to pay?
- Do you know your Solo 401(k) deadline for your entity type?
- Has anyone checked your Q4 cash needs against your estimated taxes?
If most answers are no, you don’t have a pay strategy. You have a habit.
December 31 doesn’t care how busy Q4 was. It only records what you actually paid yourself, and how.
Ready to fix the split before year-end?
Tax structure for operators who are done overpaying. Book a free strategy session and we will map your salary, distributions, and what still has to happen before December 31.
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