If you own the business you run, “how much should a small business CEO be paid?” isn’t a question about the market. It’s a question about you. You set the number, you sign the cheque, and you live with the tax and cash-flow consequences on both sides. That makes it one of the trickiest financial decisions an owner-operator makes, and one where the obvious instinct (pay yourself as little as possible and leave the rest in the business) can quietly cost you money, retirement contributions, and in some cases an audit.

This guide is for the founder or owner-CEO deciding what to pay themselves, not the board hiring an outside executive. (If you’re recruiting a CEO, see our companion piece on what it costs to hire a CEO for a small company.) It covers how owner pay actually works, the reasonable-compensation rules in the US and UK that constrain your choices, and how to arrive at a defensible number.

Why Owner-CEO Pay Is a Different Question Entirely

A hired CEO negotiates one number: total compensation. An owner-CEO faces a fork the employee never sees, because the money can leave the business in two forms with very different tax treatment. You can pay yourself a salary, which is taxed as employment income and carries payroll taxes. Or you can take company profit as a distribution (a dividend in the UK, a shareholder distribution in the US), which is generally taxed at a lower rate and escapes payroll taxes entirely.

That gap is the whole game. It creates a powerful incentive to pay yourself a tiny salary and take everything else as distribution, and it’s exactly why tax authorities in both countries have rules to stop you going too far. Understanding those rules is what separates a defensible pay decision from an expensive one.

The US Picture: Reasonable Compensation and the S-Corp Split

If your business is an S-corporation, the salary-versus-distribution split is the central tax decision you make each year. Salary (W-2 wages) is subject to the 15.3% self-employment tax: 12.4% Social Security plus 2.9% Medicare. Distributions are not. So every dollar you move from salary to distribution saves roughly 15 cents in payroll tax.

The catch is the reasonable compensation rule. The IRS requires that an S-corp shareholder who works in the business must pay themselves a reasonable salary, defined as what you’d pay someone else to do your job, before taking distributions. You cannot pay yourself $10,000 and take $200,000 in distributions simply because it saves tax. The IRS actively audits this pattern, and courts have consistently sided with the IRS: in the well-known Watson case, a CPA who paid himself $24,000 while taking $203,000 in distributions had a large chunk of those distributions reclassified as wages, with back payroll taxes, penalties, and interest.

A few things worth knowing about how the IRS judges “reasonable”:

• There is no official ratio. The popular “60% salary / 40% distributions” rule of thumb is industry shorthand, not IRS guidance. No revenue ruling or court case establishes it, and the IRS evaluates each case on its facts.
• Zero salary is a guaranteed red flag. Paying yourself nothing while taking large distributions is the single most reliable way to trigger scrutiny, and courts have uniformly ruled against it.
• The factors are the job, not your needs. The IRS weighs your training, experience, duties, time spent, and comparable wages, not your personal living expenses. A useful method for owners who wear several hats is to break your role into functions (say, strategy, sales, and delivery) and assign each a market rate.

Set the salary too low and you invite reclassification and penalties. Set it too high and you overpay payroll tax, forfeiting the very benefit the structure exists to provide. The goal is a defensible market-rate figure you can document, and documentation matters, since a written compensation memo with market data is the strongest evidence if the IRS ever asks.

The UK Picture: Salary Plus Dividends

UK owner-directors face a structurally similar choice with different mechanics. The standard approach is a low salary topped up with dividends. Salary carries income tax and National Insurance; dividends carry neither National Insurance nor employer NI, and are taxed at lower dividend rates, which is what makes the combination more efficient than salary alone.

For the 2026/27 tax year, the personal allowance is £12,570 and the tax-free dividend allowance is £500. Dividend tax rates rose by two percentage points from 6 April 2026, to 10.75% at the basic rate and 35.75% at the higher rate. Most guidance now points to an optimal director’s salary of £12,570 (the full personal allowance) rather than the traditional £5,000 floor, because at £12,570 the Corporation Tax relief on the salary typically outweighs the employer NI cost. A director on a £12,570 salary can then draw dividends up to roughly £37,700 before hitting the higher-rate threshold.

Two important caveats for UK owners. First, the optimal salary genuinely depends on whether your company qualifies for the Employment Allowance; sole-director companies with no other employees do not, which changes the maths. Second, a very low salary can drop you below the Lower Earnings Limit (£6,708 for 2026/27), which is the threshold for earning a qualifying year toward your State Pension. Saving a little tax today by underpaying yourself can quietly cost you pension entitlement, one of several reasons the lowest possible salary is rarely the smartest one.

Note: tax thresholds and rates change most years, and both the US and UK figures above are specific to 2026. Treat this as orientation, not personal tax advice. The right structure depends on your full financial picture, and a qualified accountant should confirm your specific numbers.

A Note on the Rest of Europe

The salary-versus-distribution tension exists across most of Europe, but the specifics vary sharply by country. Many jurisdictions impose their own version of a reasonable-salary or minimum-remuneration rule on owner-managers precisely to prevent profit being dressed up as dividends to dodge social contributions. Germany, France, and the Netherlands each treat managing-director compensation differently, and social-security treatment in particular differs from the Anglo-American model. If you operate outside the US or UK, the principle (pay yourself a defensible salary before distributing profit) still holds, but the thresholds and rules are local. Local advice is essential.

How to Actually Set Your Number

Cutting through the jurisdictional detail, a sound owner-CEO pay decision follows the same logic anywhere:

• Start with market rate, not survival rate. Ask what you’d have to pay someone to do your actual job, all of it. That figure anchors your salary and is the number a tax authority will test against. Your personal budget is a separate question.
• Layer distributions on top, not instead. Once a defensible salary is set, taking further profit as distributions or dividends is where the genuine tax efficiency lives, legitimately, and without the audit risk of a suspiciously low salary.
• Don’t sacrifice the long term for a small saving. Underpaying yourself can erode retirement contributions (US) or State Pension qualifying years (UK), and can weaken your income evidence for a mortgage. The lowest-tax option and the best option are not always the same.
• Revisit it annually. Thresholds move, and your profit moves. A number that was optimal last year may not be this year, and both countries’ rules changed for 2026.
• Document your reasoning. A short written rationale with the market data you relied on is cheap insurance in both jurisdictions.

The Bottom Line

Small business CEO pay isn’t really a single number. It’s a structure. The salary portion answers to the tax authorities and should reflect what your role is genuinely worth; the distribution portion is where owners capture legitimate tax efficiency. Get the split backwards, with a token salary and outsized distributions, and you trade a modest saving for real risk. Get it right, and you pay yourself fairly, stay defensible, and keep more of what the business earns.

The owners who handle this well treat their own compensation with the same rigour they’d apply to hiring someone else for the job: a market-rate salary they can justify on paper, profit taken sensibly on top, and a quick annual review to keep pace with changing rules. It’s less about extracting the absolute minimum and more about building something that holds up: to the tax authority, to your future self, and to the business’s cash-flow needs.

Looking to recruit your next C-suite leader? CEO Worldwide specializes in international executive recruitment, connecting businesses with top C-level talent across 183 countries in as little as 7 to 10 days. Contact us to learn more about our executive recruitment services.

Small business owners are the true heroes of any economy

Unlike publicly traded firms, private firms have to earn their capital – no public stock issues for them. The injustice is that when small business owners (SBO) try to get their capital out of the business when they exit, they have to compete with publicly traded firms.

The SBO has for many years been contending with competitors across town or across the state. At the exit point this competition continues and is compounded by the realization that there will be an additional contest with publicly traded capital markets.

For example, let us assume that an SBO has managed to generate C-corp after-tax profits of $200,000 per year for five years. At a handsome premium multiple of, let us say, 5 times, the privately owned business can be valued on paper at $1 million at least.

The problem is that the SBO will be extremely lucky to get $1 million for the shares of the business. That’s because an investor will look to large dividend-paying publicly traded stocks as a first choice. These investments offer instant liquidity, capital guarantees with options, the best management that money can buy, no employees to manage, no worker’s compensation forms to fill in, and no tussles with the IRS over deductible operating expenses at tax time. Look closely and you can see the annual increase in shareholder value rising at about 15% (including dividends) year after year for decades for large blue chip companies. Shareholders demand such increases from management to offset risk, so CEOs deliver earnings that reflect the demand. These large firms saw the price of their stocks plunge during the recent financial crisis, but once the recovery is in full swing they will revert to their long-term mean. That’s one explanation for Berkshire-Hathaway’s buying spree in the last 18 months.

SBOs get frustrated when they look at offers for their shares. Quite often they have return on sales, equity, assets and capital that would make the CEO of a publicly traded firm envious. Yet small businesses are not attractive because they are not liquid. As a result, many SBOs put off making plans for an exit until it is too late.

A few SBOs do manage to accumulate sizeable cash balances and accompanying retained earnings accounts. Yet even these sustain a tax hit from the IRS. Tax-paid capital on the balance sheet, when the retained earnings are paid out, becomes income, taxable at the prevailing dividend tax rates.

However, extracting a large, one-time cash balance is tough for any business. Successful SBOs have long-standing relationships with their suppliers, lenders and, most importantly, their employees. In addition, SBOs have usually not made maximum contributions to 401Ks and other personal pension schemes; as a result, they are in conflict at retirement with their own needs and the needs of the business as an entity for the benefit of customers, employees, lenders and suppliers.

A small fraction of SBOs will be bought out by publicly traded firms or perhaps even go public. But this is not the norm for SBOs. If a cash payment at five times earnings is not likely, then perhaps a junior but promising employee could be enticed to take over the reins and ownership by means of a “buy out”?

This appears to be an appealing prospect. The junior person will likely know the business very well, have lots of drive and a good technical business education. However, when the junior executive consults his personal CPA, he will find that on average, the total after-tax cash flow required to execute a buyout over 10 years at 6% and current corporate tax rates will amount to approximately twice today’s asking price of, for example, $1 million.

The junior executive will have to generate sales revenue, pay tax on the profits, pay interest on the debt and, of course, pay the principal. The misfortune in this case is that the junior executive will have to have earned about $2 million in cash to make the transaction work, and he will be ten years older and won’t have created any wealth for himself.

Not many junior executives with today’s level of education would sign on to such a deal. So if this type of exit is not viable and public markets create an overwhelming arbitrage situation that militates against a buyout commensurate with the true value of the business, other solutions are required.

One possible solution is to move after-tax cash profits as dividends to a holding company owned by the SBO. Once there, they can be inserted into a life insurance policy for tax-sheltered accumulation. A long-term cash accumulation of about 5% is possible even with the cost of insurance factored into the policy.

As for liquidity, instead of withdrawing cash from the policy, the shares of the corporation can be assigned to a bank for a series of capitalized loan payments or CLPs. These are similar to reverse mortgages.

Such capitalized loans will grow well into the future. The life insurance company will pay off the loans, and the balance of the life insurance proceeds can go to the holding company from which it can eventually be dispensed to shareholders – one of which will be an estate.

The principles of this strategy are straightforward: the present value of tax paid on dividends withdrawn from a corporation today is much greater than the accumulating future value of the interest capitalized by a lender.

The tax collectors still get their tax on stated earnings from the lender and from the life insurance company on earnings from operations. In effect, the SBO has uploaded his tax payable today to organizations with the resources to pay it.

About the author: John Lindsay has been working as an independent financial consultant to firms in Canada, USA and Europe for over 30 years, and is an Accredited Associate of the Institute for Independent Business.

View John’s short bio