How are owner's draws taxed? A guide for small business owners

For many small business owners, taking funds out of their business is sometimes unavoidable. But while this action — called an “owner’s draw” — is straightforward in theory, there are some tax nuances.

In this article, we'll break down what an owner's draw is, how it's taxed, its impact on your financial statements, and how it differs from a salary.

What is an owner's draw?

An owner's draw allows you, as the business owner, to take money directly out of your business accounts for personal use. For sole proprietors, partnerships, and certain limited liability companies (LLCs), drawing funds from the business is a common method of paying oneself without running payroll.

Are an owner's drawings taxed?

Owner's draws aren’t taxed as individual income at the time of withdrawal. However, the amount drawn does have tax implications.

For sole proprietors, partnerships, and some LLCs, the Internal Revenue Service (IRS) considers your business income as “pass-through,” meaning it passes through to your personal tax return. As a result, you pay tax on the business's profits — not on each individual draw taken.

As a business owner, you’re also generally responsible for paying self-employment taxes on your income (such as Social Security and Medicare contributions). This is calculated based on your business's net earnings, and owner’s draws do not reduce the amount you owe in self-employment tax.

In other words, regardless of how much or how little you draw, taxes are based on your business’s profits. Because of this, an owner’s draw may feel different from a salary, which is taxed at the time it’s issued.

Owner's draw vs salary: Which is better?

As a result, you may be wondering which approach is better: owner’s draw or salary. To make the best decision, consider the following:

Owner’s draw

Draws offer flexibility, as you can take out money as needed without a fixed schedule. This can be ideal for sole proprietors or LLC owners who may not have a steady income stream. However, as mentioned, draws do not reduce business income for tax purposes.

More suitable for: Sole proprietors, partnerships, and LLCs.

Salary

Paying yourself a salary provides a regular income and, in certain cases (like for S-corporation owners), is necessary for tax purposes. Salaries are subject to payroll taxes and are deductible expenses for your business, which can reduce taxable income. However, they require formal payroll processing, which can be more complex to manage.

More suitable for: S-corp owners.

How does an owner's draw affect the balance sheet?

On the balance sheet, owner’s equity reflects your investment in the business. An owner's draw decreases this equity, since it represents money being taken out of the business.

Where does an owner's draw go on the income statement?

Owner's draws do not appear on the income statement; they only affect the balance sheet. This is a significant distinction, as business expenses that reduce taxable income — like payroll — do show up on the income statement.

This means that owner’s draws don’t reduce your company’s taxable income the way traditional payroll expenses do. The total business income remains fully taxable, regardless of how much you withdraw for personal use.

Finding the right balance for your business

Understanding how an owner’s draw affects your tax liability, balance sheet, and income statement is crucial for making informed financial decisions. With this knowledge, you can confidently manage your earnings, optimize your tax strategy, and keep your business finances in check.

Alternatively, if you don’t have the time or resources to manage your payroll tax obligations confidently, you can work with a quick, easy, and reliable payroll tool, such as Remote Payroll. We ensure that your business remains fully compliant with all relevant payroll tax laws, saving you time, money, and countless headaches in the process.

To learn more about how Remote can help your small business, speak to one of our friendly experts today.

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