How to record owner draws and contributions

An owner draw is money you take out of your business for yourself. An owner contribution is your own money that you put into the business.

Both are equity. Equity is the part of the business that belongs to you. A draw is not an expense, and a contribution is not income. So neither one changes your profit.

The short version

• Pay to yourself is an owner draw, not a salary or wage.
• Money you put in from personal savings is an owner contribution, not income.
• You pay tax on the profit of the business, not on what you draw.
• A personal bill paid from the business account is a draw.
• A business bill paid with your personal card is a contribution.
• This is for sole proprietors and single-member LLCs taxed as one. Partnerships and corporations work differently.

Words to know

• Equity: what the business owes to you, the owner. It is what you put in, plus profit, less what you took out.
• Sole proprietor: a person who owns a business alone and has not formed a company. A single-member LLC is treated as a sole proprietorship for federal income tax unless the owner elects otherwise (IRS Topic 407).

Why a draw is not a salary

A sole proprietor is the business. There is nobody else to employ you. Publication 334 says: “You can’t deduct your own salary or any personal withdrawals you make from your business. As a sole proprietor, you are not an employee of the business” (Publication 334). The Schedule C instructions say not to include amounts paid to yourself as wages (Instructions for Schedule C).

So the IRS taxes your profit. If you take out all of it or none of it, your Schedule C shows the same number. Self-employment tax is also figured on profit, not on draws.

Why a contribution is not income

When you move your own savings into the business, no customer paid you. If you record it as income, you pay tax on money you already had. Publication 583 says to note the source of each deposit as business income, personal funds or loans (Publication 583).

Draws that hide

• Personal bills from the business account. These are draws. Personal expenses are generally not deductible (IRS FAQ).
• Your federal income tax or estimated tax. It is your personal tax, even when the business account pays it. Publication 334 says: “Do not deduct federal income tax.”
• The personal part of a mixed bill, such as a phone you use for both. Publication 334 says to separate the personal part from the business part.

What the entries look like

Each entry has two sides: the bank account and an equity account.

A draw lowers your bank balance and your equity together. A contribution raises both. Most bookkeeping apps write these entries when you choose the category.

An example

Maya is a freelance designer. (She is an example, not a real person.) She paid herself $4,000 each month and called it “Salary” in her books. Her Profit and Loss showed a $48,000 wage expense, and a profit much lower than her tax return.

She moved those twelve lines to owner draw. She also moved her $9,600 of estimated tax payments to owner draw. Here is her first year:

Now her Profit and Loss shows $62,000, the same as her Schedule C.

A Righto tip

In Righto, Owner Draw and Owner Contribution are ready-made categories. The Balance Sheet shows your equity. See transfers and owner money.

Common questions

Is an owner draw taxable? Not on its own. You pay tax on the business profit whether you draw it or not.

How much can I draw? There is no tax rule for a sole proprietor; see how to pay yourself as a sole proprietor. Leave enough for bills and for the tax on your profit. See how much to set aside for taxes.

Does this work for an S corporation? No. An S corporation must pay a shareholder who works in the business reasonable wages (IRS). Ask your accountant.

What to do now

1. Search your expense categories for Salary, Wages or Owner pay.
2. Move those lines to owner draw, if you have no employees.
3. Move federal tax payments to owner draw.
4. Find deposits from your own accounts and move them to owner contribution.
5. Check that your profit now matches your records.

Righto is free, easy to use and needs no account.

Sources

• Publication 334, Tax Guide for Small Business, IRS
• Instructions for Schedule C (Form 1040), IRS
• Topic no. 407, Business income, IRS
• Publication 583, Starting a Business and Keeping Records, IRS
• Income and expenses (FAQ), IRS
• S corporation compensation and medical insurance issues, IRS