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Shera asks:
Q: So the owner’s draw doesn’t have any tax consequences like a salary would, correct?
A: Correct – the owner’s draw account does not have any tax consequences like a salary. As a Sole Proprietorship or single member LLC (seen as the same as a Sole proprietor to the IRS), the Net Income (the total at the bottom of the Income Statement) is your taxable income that flows through the Schedule C and to you personally on your income tax return. The IRS considers the Net Income your Compensation. However, there are some things to consider.
The Net Income should be more than Owner’s Draw, but this can vary based on Credit Card Debt, Cash in the Bank and other Balance Sheet accounts.
The Owner’s Draw account is an Equity account on the Balance Sheet, which has nothing to do with taxes. The balance sheet shows everything you owe and own, and equity simply shows money flowing in and out of the business by the owner. The Income Statement shows the income and expenses (taxable income and deductions).
When you take money out of the business as draws, “Owner’s Draws,” these are not “taxable” in that the IRS doesn’t look at that number. However, you should be paying Estimated Self-Employment taxes each quarter based on your Net Income (Revenue – COGS – All Overhead and Operating Expenses), and estimated tax liability.
So, if you’re able to pay yourself through Owner’s Draws, you most likely have a Tax Liability.
If an LLC has elected to file as an S-Corp, there are tax savings because compensation is being paid through Payroll with taxes withheld and therefore, these are business expenses that lower the Net Income. However, you are still taxed on the Net Income, so Estimated Tax Payments are still necessary.
