The basics of an owner’s draw

A business owner cannot put themselves on the company payroll and instead takes income through a withdrawal, also known as an owner’s draw. While allowed, withdrawals should be made carefully. We’ll explain what to consider, the types of owner’s draws, and who is eligible to withdraw capital from a company.

What is an owner’s draw?

In business, an owner’s draw refers to the removal of funds or assets from a company’s resources for personal use. This typically applies to sole proprietors and partners in a partnership, but owner withdrawals can also occur in certain LLC structures, though the process differs. A withdrawal does not count as an operating expense, so it does not reduce the company’s profit.

It’s important to note that while an owner’s draw reduces the company’s assets, it does not impact the profit on the balance sheet. Owner withdrawals are also referred to as “drawings,” which can include cash or assets taken for personal use. These withdrawals reduce the owner’s equity in the business, so they must be recorded accurately on the balance sheet.

Withdrawals should be clearly documented and traceable. For example, if a business owner uses a company vehicle for personal purposes or removes an item from the business for personal use, this change must be properly recorded.

Types of owner withdrawals

1. Cash withdrawal: The most common owner’s draw, where money is transferred from the business to the owner’s personal account.
2. Property withdrawal: Assets, such as tools, vehicles, or office supplies, are taken for personal use.
3. Withdrawal of use: Instead of removing an item, the owner uses it temporarily for private purposes (e.g., using a company car for personal trips).
4. Withdrawal of benefits: Company services are used for personal reasons, such as employees performing private work for the owner during business hours.

Assets crucial for the business, such as real estate or office furniture, generally cannot be withdrawn. Only when they are no longer necessary for business operations can they be taken.

Who can take an owner’s draw?

Owner’s draws are available to sole proprietors and partners in a partnership, allowing them to withdraw business profits for personal use. However, the rules differ for owner’s draws for LLCs and corporations.

• Sole proprietors & partnerships:
  Owners can withdraw funds directly from the business, but these draws are not considered wages and are subject to income tax rather than payroll taxes.

• LLCs:

  • Single-member LLCs (treated as sole proprietorships for tax purposes) can take owner’s draws.
  • Multi-member LLCs (taxed as partnerships) distribute profits to members rather than allowing traditional draws.
  • LLCs taxed as S corporations or C corporations must pay owners a salary instead of allowing direct withdrawals. Additional payments may be made as dividends or distributions.

• Corporations (S Corps & C Corps):
  Owners cannot take traditional owner’s draws. Instead, they receive salaries if employed by the company or dividends if they hold shares.

LLCs and corporations may make certain payments to owners, such as insurance premiums, but these must follow tax guidelines and be recorded correctly. Mishandling withdrawals or distributions can lead to tax issues or regulatory scrutiny.

How is an owner’s draw taxed?

The tax treatment of owner’s draws depends on the business structure. While withdrawing money from a business does not directly impact company profits, it can have tax implications for the owner.

Sole Proprietors & Partnerships

• No immediate tax on withdrawals: Owner’s draws are not considered business expenses and do not reduce taxable income.
• Income tax applies: The withdrawn amount must be reported as personal income on the owner’s tax return (Form 1040, Schedule C).
• Self-employment taxes: Since sole proprietors and partners do not receive wages, they must pay self-employment tax (Social Security & Medicare) on business profits, not on the draw itself.

LLCs

• Single-member LLCs (taxed as sole proprietorships) follow the same tax rules as sole proprietors—owner’s draws are not taxed directly, but the LLC’s profit is taxable on the owner’s personal return.
• Multi-member LLCs (taxed as partnerships) distribute profits to members, who report their share on their personal tax returns.

S Corporations & C Corporations

• S Corps: Owners must take a reasonable salary before taking distributions. Distributions are not subject to self-employment tax, but wages are subject to payroll taxes.
• C Corps: Shareholders do not take owner’s draws.

Tax implications of taking items or services for personal use

Withdrawing physical assets, such as equipment or inventory, for personal use may increase taxable business income if the asset’s market value exceeds its book value. For example, if a business owner takes a laptop with a book value of $2,000 but a market value of $2,400, the business must recognize a $400 gain as taxable income. Similarly, when company services are used for personal purposes, such as employing business labor for home repairs, the fair market value of these services must be recorded, and they may be subject to both income tax and sales tax, if applicable.

Sales tax considerations

In states with sales tax, withdrawing goods or services for personal use may trigger sales tax liability, similar to selling those goods to a third party. For example, if a product typically sells for $1,190 (including 5% sales tax like in Wisconsin, North Dakota and Louisiana), withdrawing it for personal use means the business owes $59.50 in sales tax to the state tax agency. This also applies to business assets used for personal purposes, such as using a company vehicle for a personal move.

While owner’s draws are a common practice, they must be carefully documented and taxed correctly. If you’re unsure about owner withdrawals or owner’s draw taxes, it’s best to consult a tax advisor to avoid potential issues during tax audits.

Please note the legal disclaimer for this article.