As a business owner, you might be wondering how you’ll receive compensation for your work. Generally speaking, business owners can pay themselves with salary and/or owner’s draw. While both options involve funneling money from the business to the owner’s personal bank account, there are some stark differences between the two.
Salary vs Owner’s Draw: The Basics
Let’s first go over the basic definition of a salary and owner’s draw. A salary, as you may already know, is a regular, fixed payment that’s made to a business owner or employee. It’s usually paid either monthly or biweekly and expressed as an annual sum. In contrast, owner’s draw are payments made to a business owner that are not regular or fixed. They are taken from the business’s profits and given to the owner as compensation for his or her work.
The way in which you pay yourself will vary depending on the structure of your business. If you operate your business as a sole proprietorship — meaning you didn’t set up a legal structure — you must pay yourself in owner’s draws. The Internal Revenue Service (IRS) requires all sole proprietorships to use owner’s draws for this purpose. Keep in mind, however, that you are also required to make estimated quarterly payments to the IRS based on the amount of income you expect to earn for the given year.
Limited Liability Corporation
If your business operates a limited liability corporation (LLC), the IRS also requires that you pay yourself using owner’s draws. With an LLC, you’ll have more protection over your personal assets in the event of lawsuits or other liabilities associated with your business. Nonetheless, you must still pay yourself using owner’s draws.
Corporations, on the other hand, are often required to pay owners using a salary. C-corps, for instance, are required to compensate owners using a salary, while S-corps are required to compensate owner’s using a salary with an optional owner’s draw. The key difference between S-corps and C-corps is that the former is a pass-through entity in which the business isn’t tax.
Hopefully, this gives you a better understanding of the differences between owner’s draws and salaries. If you’re struggling to determine which payment method is right for you and your business, talk with a professional accountant. They’ll help you understand the intricacies of tax laws while explaining which compensation method is appropriate for your specific business.
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