Owner’s Draw vs Salary: What is an Owner’s Draw

owners draw vs salary

As a sole proprietor, you have to claim all the money you make through your business as personal income, even if only a portion of it goes to personal use. The salary your received as the owner comes to you as a paycheck by direct deposit or other payment method. You can set it up to automatically deduct payroll taxes (just like any other employer) through a payroll tool, like Collective Payroll. Unlike a sole proprietorship, though, an S Corp owner can receive two types of income that are taxed differently — W2 salary and distributions.

You’ll need to set a salary rate that provides enough personal income, keeps your business working productively, and satisfies the IRS. Salaries that the IRS deems ‘unreasonable’ can raise flags and create scrutiny for you and your company. The biggest downside to taking a personal owners draw vs salary income is figuring out how much is “reasonable compensation” for you and the IRS. If the IRS considers your salary too high for the services you are rendering, it could raise many red flags. You can adjust your salary – and, therefore, your next paycheck – anytime.

How to pay yourself as an S Corp

If you plan to sell the business or take on investors, a salary may be a better option since it provides a more stable income stream. However, if you plan to keep the business long-term, an owner’s draw may be a more attractive option. Overall, the decision to take an owner’s draw versus a salary depends on the specific circumstances of the business and the preferences of the owner. It’s essential to consult with a financial professional to determine the best course of action for your situation. If you’re paying yourself using the salary method, you’re not affecting Owner’s Equity.

  • However, since the draw is considered taxable income, you’ll have to pay your own federal, state, Social Security, and Medicare taxes when you file your individual tax return.
  • A C corp dividend is taxable to the shareholder, though, and is not a tax deduction for the C corp.
  • On the business side, paying yourself a straight salary makes it easier to keep track of your business capital.
  • The largest advantage to having an S corporation is the self-employment tax savings.
  • There are no specific guidelines for what constitutes reasonable compensation.

The primary benefit of an owner’s draw is that it offers flexibility. You can adjust your wages based on the success of your business; a high-profit quarter would give you more owner’s equity and, therefore, a larger owner’s draw. You can also take an owner’s draw as often as you want, as long as you have enough in your owner’s equity account. An LLC, which is a legal structure for your business, could be taxed as either a sole proprietorship or an S Corp (or, rarely, a C Corp). Either tax treatment is fine for an LLC, but an S Corp election could save you money if your business earns significant revenue. Work with your accountant to determine the best way to organize and tax your business if you want to reduce your tax liability.