How do you get paid? Normally for the 95% of people who are not self-employed, this comes in the form of a biweekly check for either the hours they worked or the salary they earned. However, for many small business owners there is no salary. Unless of course you have an S-Corp, then of course you must pay yourself a salary. However, besides that exception, small business owners are paid via an owner’s draw. What is it? Is it taxable? Is there a certain amount that I must take? And do I have to pay myself? All these questions will be answered below, this is everything you need to know about owner’s draws.
What is an Owner’s Draw?
Well as it sounds it’s essentially the owner taking money out of their business in lieu of a salary. The way it works is simple, it’s really just transferring money. The journal entry for this (if you care about that sort of thing) is to credit cash for the cash being taken out and debiting the owner’s draws, which is located in owner’s equity. Also, it’s worth noting that it doesn’t really matter how you pay yourself, you can pay yourself via check, or cash, it really doesn’t matter. The main point is that you keep track of what you are paying yourself.
Is it taxable?
To sum it up, in most cases, no, owner’s draws are not taxable. This may seem strange at first glance because you would pay taxes on your salary from a W-2. And if you pay taxes on what you make why wouldn’t these draws be taxable. The reason for this is because the transaction is considered a return of capital and not an income transaction.
Think of it this way, if you make $50k from a business and take a draw of $25k you would technically have $25k in cash at the end of the year. However, you would technically be responsible for the total of that $50k and would actually have your tax liability be based on that $50k and the $25k would be irrelevant because you’re already paying taxes on the total income that the business had that year. Also it’s worth noting that there are some instances were draws can be taxable in an S-Corp as a capital gain but this is due to basis limitations. In short, it’s a good idea to take cash and basis limitations into account when taking owner’s draws.
Is there a minimum that I must pay myself?
If you have an S-Corp then yes, per the IRS you have to pay yourself a “reasonable salary”. Now what constitutes a “reasonable salary” is anyone’s guess. However, you can create a good estimate using this guide. Also, you do not have to take a schedule draw. Owners draws can be as infrequent or as common as the business owner wishes. The point is however that the owner has to keep track of all the transactions (like any transaction really).
What are some things to keep in mind when paying myself via draws?
The main thing to keep in mind is “do you have enough cash?”. While there isn’t a limit on how much you can take out of the business per the IRS, there is a practical limit. Which is the amount of cash that you need to run the business. If you take all the money one day for a luxurious vacation to Vegas or Dubai, you may not have a business to come back to. It may be worth thinking about waiting to take money out of the business when you are first starting out to ensure that you have enough cash to pay your employees and vendors.
Conclusion
In conclusion an owner’s draw is how a small business owner, pays themselves. There isn’t a minimum amount that an owner would have to pay themselves, nor is this transaction taxable in most cases. However, be aware that you have to pay taxes on all of your business net income. Also keep in mind that you will have to keep track of all transactions. What I would recommend is to use QuickBooks and make sure that you do your bookkeeping there if you have a small business.