As a business owner, you likely pay wages to employees. But when it comes to paying yourself, what do you do?
Depending on your type of business structure, you might be able to pay yourself an owner’s draw. But, what is an owner’s draw?
What is an owner’s draw?
An owner’s draw, also called a draw, is when a business owner takes funds out of their business for personal use. Business owners might use a draw for compensation versus paying themselves a salary.
Owner’s draws are usually taken from your owner’s equity account. Owner’s equity is made up of different funds, including money you’ve invested into your business.
Business owners can withdraw profits earned by the company. Or, the owner can take out funds they contributed.
Businesses that take owner’s draws
Again, certain business structures can take owner’s draws. These structures include:
- Sole proprietorships
- Limited liability companies (LLC)
In most cases, you must be a sole proprietor, member of an LLC, or a partner in a partnership to take owner’s draws.
Take a look at our handy visual below to see where your business falls:
Are owner’s draws taxable?
Do you have to pay taxes on owner’s draw? An owner’s draw is not taxable on the business’s income. However, a draw is taxable as income on the owner’s personal tax return.
Business owners who take draws typically must pay estimated taxes and self-employment taxes.
Some business owners might opt to pay themselves a salary instead of an owner’s draw. When it comes to salary, you don’t have to worry about estimated or self-employment taxes.
Determining an owner’s draw amount
When figuring out how much to take for an owner’s draw, you need to think about a few factors. You should base your owner’s draw on:
- Your business’s cash flow
- The time of year (e.g., slower season)
You should also factor in operating costs and other expenses before you decide how much to pay yourself with an owner’s draw.
Depending on your business, your draw amount might fluctuate from time to time. For example, during a peak season, you might pay yourself more because you have a higher cash flow.
Taking large draws
Taking larger draws can be risky. If the owner’s draw is too much, it could prevent the business from having sufficient funds moving forward. And without funds, a business can’t operate.
Before taking larger draws, weigh the pros and cons and perform risk analysis. Determine the maximum amount you can take in owner’s draws and stick to it.
Recording owner’s draws
When it comes to financial records, record owner’s draws as an account under owner’s equity. Any money an owner draws during the year must be recorded in an Owner’s Draw Account under your Owner’s Equity account.
At the end of the year or period, subtract your Owner’s Draw Account balance from your Owner’s Equity Account total.
To record owner’s draws, you need to go to your Owner’s Equity Account on your balance sheet. Record your owner’s draw by debiting your Owner’s Draw Account and crediting your Cash Account.
Say you withdraw $2,000 from your company. Your transaction would look like this:
Looking to streamline your accounting process? Patriot’s accounting software lets you quickly and easily record your business transactions so you can get back to your business. Get started with your self-guided demo today!
We’re always ready to keep the conversation going. Give us a like on Facebook and share your thoughts on our latest articles.
This is not intended as legal advice; for more information, please click here.