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Owner's draw vs payroll salary: paying yourself as an owner with Hector Garcia | QuickBooks Payroll - YouTube
Channel: QuickBooks
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are you asking how to pay yourself as a
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small business owner not sure if a draw
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for a payroll salary
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it's a better choice in this video i'll
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explain both
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hi everyone i'm hector garcia cpa
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quickbooks consultant and business owner
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i'm a big fan of into a quick books and
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i'm partnering with them
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to produce this video series about
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payroll
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in fact i have an entire youtube channel
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where i have tons of videos about
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quickbooks accounting
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tax and a bunch of important small
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business topics
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make sure you hit the like button if
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you're interested in seeing more videos
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on this topic today i'm going to talk
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about how to pay yourself
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as a small business owner it's an
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important decision to make
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because you need to think carefully
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about how you take your money
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out of your business in this video i'll
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share my personal recommendations
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but be sure to consult with your own
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accounting tax
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or legal advisors to make sure you make
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the right decisions
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for your business typically there are
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two options here
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you're going to have an owner's draw
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which i'll explain in a minute
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or a payroll which is often represented
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as a salary of some sort it is important
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to point out
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that most of this content is focused
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around small businesses
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which are often sole proprietorships llc
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partnerships or s-corporations now
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larger corporations
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have different rules around owner's pay
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and they're often referred to as
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dividends but that's a subject for
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another discussion
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okay let's take a look at payroll salary
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versus owner draws
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and how can you figure out which is the
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right one for you
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and your business with a payroll salary
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the business owner determines a set wage
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for themselves then cuts themselves a
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paycheck
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every pay period which will include
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taxes and other deductions
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make sure to check out the video in this
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series focused around calculating
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the net wages for more information about
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that
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in an owner's draw or what they call an
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s-corps a distribution
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the business owner takes funds out of
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the business for personal use
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draws can happen at regular intervals or
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any time when needed
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owner draws could also be represented as
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a regular check paid to the business
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owner
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or a cash withdrawal from the bank for
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these cases it is valuable to understand
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how the irs qualifies an expense to be
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deductible for the business
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according to section 162 of the irs code
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it says quote there shall be allowed as
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a business deduction
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all ordinary and necessary expenses paid
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or incurred
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for the taxable year carrying on any
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trade or business
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the key terms here are ordinary and
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necessary
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which means that an expense made by the
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business
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that is not deemed deductible under
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these rules
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it is usually treated as an owner's draw
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by default
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owner draws do not have deductions for
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taxes such as when a payroll salary is
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paid to the owner
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however since owner draws are not
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deductible expenses
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they do not decrease taxable income of
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the business
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while reducing the amount of cash
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available for the business
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therefore a business owner should always
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keep in mind
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that owner draws while they do not carry
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tax payment themselves
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they may increase taxable income which
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will mean
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a higher tax liability the last thing to
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add about owner draws
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is that even though most owner draws
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essentially come
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from the business profits sometimes the
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business owner
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will still have capital invested into
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the business
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which is defined by the amount of cash
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or assets
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contributed to the business to allow it
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to operate
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if there's still a positive balance in
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that capital account
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owner draws should technically be
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categorized as a reduction of that
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capital
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until that account is exhausted and all
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the additional
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draws after the capital has been
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depleted are officially called owner
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draws
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not return of capital let's use an
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example
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paddy owns a coffee shop and works there
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as well
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her business is an s corporation and she
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decided to pay herself a
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fixed base salary of 2 000 a month
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but chooses not to do it via payroll so
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she receives a whole amount
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via a check her business writes herself
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during the busy or high seasons she
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writes herself an additional
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discretionary amount
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based on the business's cash flow the
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advantage of a draw
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or in this case a distribution because
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it is an s-corp
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is that it provides greater flexibility
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paddy's compensation can vary based on
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her business performance
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the downside is that taxes won't be
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deducted from paddy's draws
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automatically
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so she will need to make estimated tax
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payments into her
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personal income account towards federal
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and state income taxes
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and towards self-employment taxes based
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on the estimated
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net profitability of the business which
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is calculated prior
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to making those draws now let's say
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patty chooses to pay herself a salary
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via payroll
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what's the advantage here for starters
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there's less planning work
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because taxes will be taken out out of
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her paycheck automatically
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if she's using payroll software and her
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compensation
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will be more stable making it easier for
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her to track
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income and expenses even her additional
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bonus payments
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during the good months will be subject
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to tax deductions
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in the payroll check but the potential
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downside to this
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is going to be the impact in cash flow
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with payroll her net take-home pay will
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be smaller
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due to the withheld taxes and deductions
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paddy could still do a combination of
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these some payroll
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some distribution but it will take a
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little tax planning
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paddy needs to make sure that she is
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making enough contributions
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to be able to pay her tax bill through
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the tax withholding of the paychecks
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especially if she's taking a significant
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amount of owner draws
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in addition to her regular payroll
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this is where having an accounting
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software like quickbooks and a trusted
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accountant
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by your side is the winning combination
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now let's finish up by discussing some
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best practices for your business
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step one is to understand how business
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classification
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impacts your decision because that's the
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single biggest factor
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here why because different business
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structures
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have different rules around owner's
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compensation
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a draw is the appropriate method if
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you're paying yourself as a sole
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proprietorship
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but if you have a partnership or an llc
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also known as limited liability company
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you could have a combination of owner
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draws
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and guaranteed payments a guaranteed
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payment is a taxable draw
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that takes precedence over their regular
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draws this is particularly relevant
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when multiple partners or llc members
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take disproportionate draws guarantee
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payments could be a hairy topic
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so make sure to consult with your tax
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professional on this
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now if you're paying yourself with an s
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corporation or an s corp
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the appropriate method might be a
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combination of payroll salary and
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distributions
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it is also important to keep in mind
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that with an s corporation
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you must make sure that owners receive
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reasonable compensation
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via payroll otherwise they could lose
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their s-corp status
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granted by the irs reasonable
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compensation
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sounds like a subjective term however
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this is the actual term
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used by the irs and the actual facts and
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circumstances
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of your business will determine what
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that reasonable
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amount could be make sure to consult
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with your tax professional
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on this matter as mentioned earlier if
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you own a c
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corporation and pay yourself a draw
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this is actually called a dividend and
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dividends
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are potentially subject to income tax as
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well
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triggering that dreaded double taxation
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of corporations
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you may have heard about step two
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is to understand how owner's equity
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affects your decision
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equity sometimes referred to as owner's
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capital
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it's simply the net value of your
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business what's left
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after taking your assets minus your
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business liabilities
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or your obligations as an owner you can
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increase your equity by contributing
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capital or decrease that equity
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by taking owner draws finally step three
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is to understand how much to pay
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yourself
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as a business owner there's no simple
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single answer for this
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that applies across multiple businesses
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but there are several things you should
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consider
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including how your business is
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performing and what your cash flow looks
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like
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it is true that many small business
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owners will forego their own
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compensation when cash flow is tight
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but the most important factor here as i
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alluded to earlier
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is how your business is structured so
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the key here
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is to find that perfect formula based on
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all your circumstances
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choosing that appropriate legal entity
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deciding
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how and how much to pay your business
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paying yourself in the proper manner
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and finally estimating the tax liability
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generated
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by both the profits and how you pay
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yourself
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okay that's it for this video about how
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do you pay yourself as a business owner
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remember to click that like button and
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subscribe to the quickbooks youtube
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channel
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if you still have questions about this
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topic or any other payroll topics
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leave a comment below thanks and i'll
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see you next time
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[Music]
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you
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