Owner’s draw versus salary
How money leaving the business for the owner is recorded depends on the tax entity, not on what the transfer memo says.
General information, not tax or legal advice. Entity choice and reasonable compensation are decisions for you and a licensed professional. This page explains the bookkeeping patterns in plain language. The LLC versus S corp page is the companion, still as education.
A draw is equity
In a sole proprietorship, the owner and the business are the same taxpayer. Cash moved from the business checking account to the owner is a reduction of owner’s equity. It is not an expense, so it does not appear on the profit and loss. It does appear on the balance sheet, usually in an account called owner’s draw or owner’s distributions. The business can be profitable and still have less cash because of draws. That is a runway question, not a margin question.
A personal expense paid with the business card is the same idea. Code it to draws, or reimburse the business. Leaving it in “miscellaneous” makes profit look worse than the operation was and hides how much the owner took.
A salary is an expense, and it is wages
When the owner is also an employee — the usual pattern discussed for an S corporation — pay runs through payroll. Gross wages are an expense. Employer payroll taxes are an expense. Amounts withheld from the paycheck are liabilities until they are deposited. The paycheck estimator is a rough take-home view for a salary. The payroll tax estimate separates the employer share. Neither tool decides what a reasonable salary is.
Distributions of remaining profit after that salary are equity, not a second wage. They are not self-employment tax in the way sole-prop earnings are. The IRS expects the wage to be reasonable for the work. This site does not compute a reasonable figure, and it should not be used to set one.
Partners are a third pattern
A partnership does not “pay a salary” to a partner in the sole-prop draw sense, and it does not treat a partner as a W-2 employee for that partner’s own share in the usual case. Guaranteed payments and distributions are partnership-tax ideas. IRS Instructions for Form 1065 are the place to start, with a preparer. Do not drop partner draws into wage expense just because the bank transfer looks like payroll.
What to record on an ordinary Tuesday
- Name the entity first. Sole prop, partnership, S corp, or C corp. The entity page separates the state LLC from the federal tax election.
- Use the matching account. Draws for a sole prop. Wages plus payroll liabilities for an owner-employee. Ask before you invent a hybrid.
- Do not call a draw a tax payment. Estimated tax the owner pays personally is not a business expense. Estimated tax the business pays toward the owner’s personal return is usually a draw. The estimated tax calculator works from numbers you type; it does not book the payment.
- Reconcile the transfer. The bank line and the equity or wage entry should be the same amount on the same day. The reconciliation guide is how you prove it.