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