Confused Between Salary and Owner's Draw? Hire A Bookkeeper Instead
As a small business owner, one of your primary responsibilities is to ensure that you are making the best financial decisions for your company. When it comes to payroll versus owner's draw, this decision can become complicated.
It is important to understand this distinction so that you remain compliant with both federal and state laws, as well as keep accurate financial records for your company. In this presentation by Maggie, she discussed how determining whether or not to use payroll versus an owner's draw may vary depending on what classification your business falls into.
About Maggie and PRIM Bookkeeping
Maggie Morris is the owner of Prim Bookkeeping. PRIM opened three years ago as the pandemic started but Maggie has been in the bookkeeping business for over 16 years. With the start of the pandemic and the schools closing down, she was forced to stay at home and leave her full-time job. The next day, she opened PRIM and her employer became her first customer!
Within a few months, Maggie had five customers.
From there, she started thinking about why and how she is different from her competitors. What am I gonna do differently? She asked herself.
Then she thought of creating a simple, boutique bookkeeping firm providing personalized services. There are a lot of virtual companies out there, and somehow, clients cannot feel that they are working with real people. With PRIM Bookkeeping, Maggie always tries to meet with clients whenever possible. The in-person meeting allows more effective communication in gathering client information, getting to know their operation, and seeing how they are doing financially.
Maggie does everything from setting up your file, setting the whole chart of accounts, and showing you how the software works. Maggie will prepare all the reports and you will be able to just invite your accountant to the software and everything else will be a breeze.
Why hire a bookkeeper?
Everyone has a bit of knowledge about bookkeeping and if we all know how to do it, the problem becomes the time or the actual software. However, a bit of knowledge still results in duplicated income when you don't know the workings of the software or you are not familiar with how double-entry accounting works.
To Save Time and Energy
- If you want to spend more time with your family at the end of the day, have someone like Maggie do your paperwork and books.
- If you want to implement a four-day workweek, then outsource your bookkeeping.
- If you want to focus on growing your own business and don't want to spend evenings or your free time tracking the financials, hire a bookkeeper.
- If you want accurate financials, you should hire an expert. Without a lot of experience, mistakes can happen.
Is It Payroll or Is It Owner’s Draw?
Is It Payroll or Is It Owner’s Draw? The answer is it depends.
Salary is a set wage. You pay yourself weekly, bi-weekly, semi-monthly, or monthly. And when you take that, it includes taxes and deductions. When you record that, you need to record it in a specific way on your books.
Draw (what probably most of us do) is the amount that we take out of the business for personal use. There is no set time. Taxes do not come out. You can take it out whenever you need it.
And when we take money as a draw, it's not an expense. It doesn't reduce the taxable income of the business. The drawer lives on the balance sheet, not on a profit and loss. That's why we don't really see it. It just reduces the available cash we have in the business.
If you as a business owner contributed to the business, and when you draw, take that money out of the contribution just so it looks cleaner. Once that capital account is exhausted, then you can start categorizing it as the owner’s draw. It will still give you the amounts that you've contributed, but then it will just zero out.
What's important to remember is that when you draw, you need to put the taxes that are not being taken out. As small business owners, we need to make our estimated tax payments.
“I always suggest that to my clients, that every paycheck, every check that you get from your client, you have like a separate account that you would take a percentage of that and you put it in their account so it's right there. And then when the tax time comes, you have that money for your estimated payment.”
How To Decide if Salary or Owner's Draw?
How to decide which way to go? It really depends on the business classification because different business structures have different rules.
- If you are a Sole Proprietorship, you take the draw.
- If you are LLC or Partnership, you can take the draw or something that is called Guaranteed Payments. It's a draw that takes precedence over a regular draw. This is especially important in partnerships when partners take disproportionate draws.
- As an S Corporation, that's your election, you can make that election as an LLC for your taxes. Sometimes your CPA would be able to tell you that it's more beneficial for an LLC to elect to file as an S Corp for tax purposes and savings. As an S Corporation, you need to take a salary and you can take a distribution.
- You have to make sure that the owners receive reasonable compensation via payroll. If you don't, it can result in a loss of status with the IRS. If the IRS doesn't tell you what it is, you just have to look up your position online like salary.com and you will find out the average salary for it.
- With the C Corporation, it's a little different. In the C Corporation, you need to run payroll and the owners may take the draw, but then it's called the dividend. And that's when double taxation comes into place because C Corporations are subject to it.
Again, as a Sole Proprietorship or LLC, when you record the draw/guaranteed payment on your books, make sure you record it in the equity account. It's not a salary, it's not an expense. It doesn't go on your profit and loss.
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