The two main ways of paying yourself as a business owner are an owner's draw or taking a salary.
In this article we will discuss the difference of owner's draw vs. salary in order to help you determine which type of compensation is best for you and your business.
With the owner's draw method of paying yourself, you are able to withdraw money from your business as you see fit without any set payout schedule or amount limit.
This method allows for maximum flexibility when it comes to paying yourself as you are free to take a draw whenever you like.
In contrast, when you take a salary you are paid just like any other employee on a set schedule with a set amount.
An owner's draw occurs when a business owner withdraws money from a business bank account for their own personal use.
This can be done at any time and for any amount that is available within the business bank accounts.
The main benefit of taking an owner's draw is the flexibility associated with this option.
With an owner's draw, you are able to pay yourself from the business at any time, which allows you to adjust the amount you receive based on how the business is performing.
The main con of taking an owner's draw is that taxes are not automatically deducted.
Therefore, it is essential that you keep detailed records of your payouts so that you know how much you owe come tax time.
As a business owner, if you receive a salary then you will receive fixed-amount payments on a regular basis just like an employee.
One major pro of taking a salary is that state and federal taxes are automatically deducted from your paycheck.
Also, taking a paycheck as compensation from your business will allow you to show banks a steady source of income that will make it easier to take on a mortgage or other loan.
Further, being paid on salary from your business will make it easier for you to keep track of your business expenses as salaries are normally paid on a fixed schedule.
The main con of taking a salary as payment from your business is that you must determine your 'reasonable compensation' that doesn't set off any warnings for the IRS.
When choosing your own salary, be sure to choose an amount that keeps the business operational while also allowing you to enjoy your personal life outside of the business.
According to the IRS, 'reasonable compensation' is defined as "an amount that would ordinarily be paid for like services by like organizations in like circumstances.”
This means that you should be paying yourself similarly to other companies that are earning as much, are the same size, and in the same industry as your business.
These rules exist in order to stop business owners from paying themselves a decreased salary in order to misrepresent the businesses finances.
It is also worth noting that 'reasonable compensation' does not apply to sole proprietorships or partnerships.
Taking an owner's draw is great for business owners that are looking for more flexibility with their compensation, but be sure to keep detailed records of your withdrawals as these distributions are subject to taxes.
Taking a salary as a business owner is best for people needing more structured payouts that make it easier to track business expenses for the period.
At the end of the day, you will need to decide which distribution method is best for you based on your own situation and type of business.
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