How to Pay Yourself With an Owner’s Draw

What is an owner’s draw? 

An owner’s draw is when an owner of a sole proprietorship, partnership or limited liability company (LLC) takes money from their business for personal use. The money is used for personal expenses and replaces a traditional salary.

How does an owner’s draw work?

An owner’s draw can help you pay yourself without committing to a traditional 40-hour-a-week paycheck or yearly salary. Instead, you withdraw from your owner’s equity, which includes all the money you’ve invested in the business plus any profits and losses.

Owner’s draws aren’t limited to cash withdrawals, such as debiting from an ATM, transferring money between accounts online or writing a paper check. Business owners can also benefit from material goods perks. For example, if your company has discount opportunities with vendors, it can purchase the discounted goods and give them to you. The price of the goods would also be considered a draw.

Owner’s draws are ideal for business owners who work more than 40 hours a week or have significantly different profits from month to month. Plus, if you are a sole proprietor, taking a draw is the only way to receive income from your business.

If your business has co-owners, consult them before taking an owner’s draw. Hiding draws can lead to distrust and cash flow problems.

What types of businesses can take an owner’s draw?

Owners of some LLCs, partnerships and sole proprietorships can take an owner’s draw. S corporations (S-corps) and C corporations cannot take draws. However, corporation owners can use salaries and dividend distributions to pay themselves.

How an owner’s draw affects taxes

There are few rules around owner’s draws as long as you keep up with your withdrawals with the IRS. You can take out a fixed amount multiple times (similar to a salary) or withdraw different amounts as needed.

Since draws are not subject to payroll taxes, you will need to file your tax return on a quarterly estimated basis. However, all owner’s withdrawals are subject to federal, state and local income taxes and self-employment taxes, including Federal Insurance Contributions Act (FICA) taxes (Social Security and Medicare).

Owner’s draws should not be declared on your business’s Schedule C tax form, as they are not tax deductible. If you are looking to boost your tax deductions, pay yourself a salary that is considered deductible through the IRS.

If you are unsure which owner’s payment method is best for your business, contact a trusted certified public accountant or attorney who can walk you through the best way to withdraw money from your business to your personal account while saving money on taxes.

How to determine how much to draw

When taking an owner’s draw, your books must be current so you know your equity balance and ownership interest value. Your equity balance is the total of your financial contributions to the business, along with the accumulation of profits, losses and liabilities.

If you draw more than your business ownership or what your business is worth, you will borrow money from your business worth and create a loan. You can create tax complications once you withdraw more than the business is worth.

Once you have an amount in mind, consider the following factors before making an owner’s draw:

• Business cash flow: Will the amount you draw cause the business to have cash flow pinch points? Ensure your withdrawal amount doesn’t affect operations, so you continue to make a profit and can make future draws if needed.
• Ownership agreement: Does your business have multiple owners? Multiple-owner businesses might have partnership agreements that require approval of a draw and limit the amount you can ask for as a co-owner. Even if you don’t need permission, financial transparency should always be at the forefront of your actions. The more straightforward you can be with your business partners, the better. If you explain your financial situation, co-owners are more likely to help you before it affects the business.
• Multiple draws: You don’t have to commit to one lump sum for the year when you take an owner’s draw. Take what you need for your current expenses and opt for additional draws as needed. Taking multiple draws can help you better manage your money and keep maximum cash flow available for your business.

How to track and record your draws

Staying on top of your draws is crucial for accurate and transparent financial accounting. Consider the following methods.

Spreadsheet

A spreadsheet is one possible way to track the owner’s withdrawals. However, you will need bookkeeping experience and the ability to make a custom spreadsheet, as most online spreadsheet templates do not have this option.

Maintain a balance sheet to track all the money you take in and out of your business. Tracking this money will help you determine if the company is still profitable after you transfer cash from your business account to your personal account.

Payroll software

Most of the best payroll services will set up an equity account as part of the overall accounting structure and payroll process. However, this default equity account often isn’t specific to the money you take out of the business.

It’s best to create a new equity account for your owner’s draws. Once this custom equity account is set up through your software, you can run reports periodically to keep track of all the money moved from your business account to your personal account.

A balance sheet is essential if you take multiple draws or draws in different amounts. The software will track each draw automatically to monitor your spending.

Alternatives to taking a draw

While not all businesses have multiple options for paying owners, some owners have choices. Consult a tax professional if you are unsure of the best way to pay yourself. Typical options include the following.

1. Salary

To be paid a salary, business owners must classify themselves as employees. A salaried worker receives a fixed payment on a pay schedule decided by the company, regardless of the hours they work.

Salaries are subject to payroll taxes at the time of payment. Both salaries and payroll taxes can be classified as business expenses and deducted from your business’s taxes. Paying yourself a salary as a business owner is beneficial because it can reduce your business’s net income.

2. Guaranteed payments

Guaranteed payments are fixed amounts that mirror a salary; they’re prevalent in partnerships. They can help you securely plan for your future each year, even if the business is in the red. If you request a guaranteed payment, all terms must be stated in the partnership agreement. 

Guaranteed payments are not taxed as income and no payroll taxes are withheld from your company. They can be listed as distributions or partnership income. The payments are tax-deductible as a business expense, unlike owner’s draws. Like salaries, guaranteed payments also lower your business’s net income.

3. Dividends

Dividends are a shareholder distribution and include a portion or all of the business’s profits since its establishment.

For example, a sole proprietorship that earned $200,000 in profits and has $400,000 in cash has up to $200,000 in available dividend distributions. If more cash funds are needed, the sole proprietor must use an owner’s draw to make up the difference.

The best payroll software for managing owner’s draws

Over our years of testing payroll software, we’ve found the below platforms especially useful for tax compliance, a key consideration when taking owner’s draws:

• Paychex: With more than 200 in-house compliance experts, Paychex ensures that, when you take owner’s draws, your business files the required quarterly taxes. Paychex guarantees accurate tax calculations and covers any penalties that result from errors. Read our Paychex payroll review to learn what other features this service includes.
• ADP: As with Paychex, ADP guarantees that its tax calculations are accurate and pays any penalties that stem from errors. While reviewing payroll services, we found ADP’s team especially easy to reach with questions, including about owner’s draws. Check out our ADP payroll review to discover why this vendor has long been a leader in the payroll space.
• QuickBooks Payroll: This payroll service stands out for inherently and fully integrating with QuickBooks Online, which ranks among the best accounting software. Although QuickBooks offers only partial coverage of erroneous tax calculations, its seamless connection to QuickBooks Online makes mistakes incredibly unlikely. Explore the payroll offering from accounting software’s leading name via our QuickBooks Payroll review.
• OnPay: Another vendor that promises timely and error-free tax calculation, OnPay stands out for offering all its features to all users. This contrasts with the overwhelming majority of payroll services, which relegate their features to specific pricing packages. Learn all about what you get with OnPay’s only pricing package via our OnPay review.
• Rippling: This vendor guarantees tax compliance, covers penalties and handles international taxes. Rippling is therefore a great option if you’re taking owner’s draws from a business that operates across borders. Discover what else you get with this payroll service via our Rippling payroll review.

Drawing a conclusion

To take or not to take owner’s draws — that is the question. You may find owner’s draws more convenient for adding flexibility to your personal cash flow, but you may be anxious about how unfamiliar they feel. In that case, there’s certainly nothing wrong with using the best payroll software for one-employee businesses to pay yourself as an employee. After all, you work for your business even when you own it. Make yourself an employee with a salary or take owner’s draws — the choice is yours based on all the advice above.

Max Freedman contributed to this article.