Salary vs. Owners Draw – Paying yourself by your business type/entity
“Time is money” as we all are aware. Most individuals cannot afford to work without receiving compensation. It is quite important therefore, to know the correct method of which to receive compensation from your business/organization.
You must first understand the difference between Salary vs. Owner’s Draw. A Salary is a business owner’s predetermined “Reasonable Compensation”, as determined by IRS guidelines, as a set wage occurring every pay period. Adversely, an Owner’s Draw (a.k.a. “Draw”), are funds removed from the business by the owner occurring at either regular periods or as needed.
A Sole Proprietor, Partnership and Limited Liability Corporation (taxed as a Sole Proprietor) are all required to take an Owner’s Draw.
An S-Corp receives a Salary and possibly, Distributions. To avoid withholding self-employment taxes on the entire amount, a business owner may take a portion of their compensation as a Distribution (from previously taxed earnings at the higher rate.)
Owner(s) of a Corporation (a.k.a. Shareholders) receive a Salary & possibly, Dividends (distributions of the company’s profits.)
Nonprofit Corporations have no owners however they have a Board of Directors. A Board Member may be eligible to receive a Salary but it must be voted on and approved by the Board of Directors (notwithstanding the individual in question) and be a permanent part of the Board Minutes.
Although there are many variables, the largest factor is dependent upon the type of business entity/structure and ensuring enough equity remains in the business to operate into the future after compensation is made. Thereafter, it is recommended to review IRS guidelines regarding “Reasonable Compensation” and seek the advice of a professional Bookkeeper, Accountant or Tax Professional.