Owner’s Draw

What is an owner’s draw?  

An owner’s draw can simply be stated as an amount taken out by the owner for his or her personal use. Note, a self-employed business owner does not usually take a salary. Instead, he or she makes an initial investment in the business from personal funds and during the course of the business takes money out as draw and invests more money, from profits or from personal savings.

How much can a business owner actually take as a Draw?

Business owners can take any amount they want from their business.  Recently, s-corporation owners have been going overboard and taking unreasonable amounts as draws, and not including themselves on the company’s payroll. The reason for this is to avoid paying payroll taxes. Keep in mind you shouldn’t take money that will be needed to pay employees, pay off business loans, or pay other bills of the business.

What is considered “reasonable compensation” for a S-Corporation owner?

There are no specific guidelines to determining reasonable compensation. The IRS has stated that they make the determination on a case by case basis. NOLO.com lists the following factors that the IRS considers in their determination:

  • the duties performed by the employee
  • the volume of business handled
  • the type of work and amount of responsibility
  • the complexity of the business
  • the time and effort devoted to the business
  • the timing and manner of paying bonuses to key people
  • use of a formula to determine compensation
  • the cost of living in the locality
  • the ability and achievements of the individual employee performing the service
  • the pay compared with the gross and net income of the business, as well as with distributions to shareholders
  • the company’s policy regarding pay for all employees, and
  • the payment history for each employee.

Sources:

  1. http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/Paying-Yourself
  2. http://www.nolo.com/legal-encyclopedia/s-corporations-salaries-an-irs-hot-button-issue.html