Can I Take an Owner’s Draw with My Company?

Business Types

Understanding your business type is very important. There are multiple types of businesses, and they are all treated differently for tax purposes. Sole Proprietors, Partnerships, and Limited Liability Corporations are pass-through entities.

Pass-through entities mean your business’s profits or losses are taxed as personal profits or losses. This can create fluctuating annual income, making it more difficult to plan long-term.

S Corps and C Corps both function as corporations and face slightly different tax treatments. S-Corps removed the self-employment tax and are taxed on wages and profit. C-Corps are taxed as corporations utterly separate from personal taxes.

What is a Profit or a Loss

Another essential thing to know is what profit is and what a loss is. Before we can understand either of those things, we first need to understand income and expenses vs assets and liabilities. We may all be familiar with income – the money received from sales or services, but do you know the difference between an expense and a liability?

Expenses are business costs, such as advertising, wages, rent, utilities, and fuel if your business calls for travel. Expenses go against your income and are recorded on an Income Statement or Profit and Loss.

There are only two sections on a Profit and Loss: income and expenses. If there is money left, your income is higher than your expenses; this is a net income. Contrarily, if your expenses exceed your income, that is a net loss. Our equation would then be: Income – Expenses = Profit or Loss.

Liabilities are debts your business owes, such as loans or obligations to state or federal agencies.

Assets are broken down into current, also known as liquid, and fixed. A liquid asset refers to an asset that you can easily convert to cash, such as a bank account, a loan you give to others, or money customers owe you for completed services (accounts receivables). Fixed assets are items that are more difficult to turn into cash, such as vehicles or equipment. Both assets and liabilities are located on the Balance Sheet.

Unlike the Profit and Loss, the Balance Sheet contains three items. We have already reviewed assets and liabilities. The final area is known as Equity. Business Equity is the value of a business if the assets are used to pay all the liabilities.

Therefore, our equation for the Balance Sheet would be: Assets – Liabilities = Equity.

Unfortunately, the Balance Sheet is not set up so simply. Balance Sheets are separated into two sections with Assets at the top, and liabilities and Equity are at the bottom. The official accounting equation is Assets = Liabilities + Equity. Our equity section will show either our Net Profit or Net Loss.

Each month, your net income and/or net loss from your Profit and Loss are added together and placed on the Balance Sheet as Net Profit or Net Loss. This net profit or net loss determines your taxable income. For the pass-through businesses mentioned above, this is your taxable income. For C-Corps, this business profit will be taxed as a corporation.

Can I take some of the profit out of my company? 

Removing profit from the company is also known as an Owner’s Draw. Most small businesses start as either a sole proprietor (single owner) or a partnership (multiple owners). This company type is the base level. In order to receive money from your business, an owner’s draw is the only way.

You will not receive a W2 at the end of the year since all the money the business makes will be considered your income.

However, knowing that you do not want to drain your business of all its profit completely, or funds will not be left to help your business grow or as a safety net for a bad month. You also do not want to use the business accounts as personal accounts. It is more beneficial to your business growth to transfer lump sums of $1,000, $2,000, or even $8,000 into your personal account on a regular basis.

Partnerships

For partnerships, you want to ensure each partner takes equivalent amounts according to the partnership percentages. If your partnership is set up for a 50/50, each of you is removing the same amount as draws. If one partner takes out more than the other, the partner that has taken less will have more Equity in the company.

Equity is tracked for cases such as a sale of the business or partnership buy-outs and is reported on each partner’s taxes each year.

Limited Liability Corporations

The next type of business is the Limited Liability Corporation (LLC). LLCs are a hybrid business. It is still taxed on a pass-through basis like a sole proprietor or partnership, but it comes with some personal liability protections of a corporation.

Those protections include limiting loss due to litigation to business assets only or vice versa if the lawsuit is personal. However, if you are intermixing your funds, using the business funds as personal funds, the benefits of the LLC are void. In the case of a lawsuit, business and personal assets would be considered one and the same.

Lawsuits could result in losing all your business and personal assets that the LLC was established to protect. In the case of an audit, mixing funds is seen as a red flag that could cause the auditor to take a closer look at each expense account to determine if any other personal items have been hidden as tax write-offs.

Who can get a paycheck?

We discussed two other business types at the beginning: S-Corps and C-Corps. Both of those types require employees to be paid with a paycheck.

S-Corp Election

With an S-Corp, you are still able to take an owner draw. However, the owner’s salary and the owner’s draw are reported to the IRS each year on your taxes. A red flag to the IRS is having a large owner draw and a lower-than-average salary. S-Corp status is an election, and some requirements come with the election.

One of those is the requirement to pay yourself a reasonable wage. This amount is not defined, and asking around will result in different answers. The most standard answer is: how much would you expect to be paid for this position if you worked for someone else? One of the benefits of S-Corp status is not having to pay self-employment taxes (including Medicare and Social Security) on the business profit.

Failing to pay yourself or underpaying yourself means you are not paying the correct amount of tax to Medicare and Social Security, leaving these underfunded. Failing to pay yourself a reasonable salary could result in losing your S-Corp status and the massive tax savings that come with being an S-Corp. Getting the S-Corp status back once it has been lost is difficult, and there is a minimum five-year waiting period.

C-Corp

Lastly, the C-Corp. Like the S-Corp, you will want to take your pay as a paycheck. However, unlike the S-Corp, you will not want to take additional draws, as these are double-taxed. Any amount taken as an owner draw with the C-Corp is taxed as taxable income under corporate taxes and then as earned income at your personal tax rate.

For C-Corps, you are either going to want to define guaranteed dividends in your business operations agreement, increase your pay through the business, or provide it as a bonus.

To summarize, net profit on the Balance Sheet lets you know how profitable your business is for the total year. For sole proprietors, partnerships, and LLCs, it is highly recommended that funds be transferred from the business account to a personal account in lump sum payments, and the business account is not used for personal expenses.

Make sure you are not overdrawing (taking more than the profit amount), as this can have other consequences in the future. S-Corps and C-Corps require you to be paid with a paycheck. S-Corp can take an owner’s draw once it has been determined that a reasonable salary is being paid. It is best to avoid any owner’s draw for C-Corps altogether, as any funds withdrawn as an owner draw will be double taxed. Check out our youtube video As a business owner can I take an Owner’s Draw? with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.

If you have further questions, please reach out to us.