How do I get money out of my business?

How do I get money of my business?

How you get money out of your business depends on the type of business entity you have.  With several business entities, the strategy is the same, but the terms used to describe the withdrawal of money are different.  This article provides a short summary of the most common ways to get money out of the most common business entities.

 

How to get money out of my sole-proprietorship?

A sole-proprietor withdraws money from his business simply by transferring money from his business bank account to his personal bank account, or by writing himself a check out of the business bank account.  This transaction is referred to as an “owner’s draw” and should be recorded in the books as such.  An owner’s draw is not a deductible business expense, nor is it considered taxable income to the business owner.

 

How to get money out of my c-corporation? 

C-corporation shareholders can take money out of their corporations in two ways:

  1. Salary/Wages: C-corporations usually pay their shareholder officers a salary in exchange for their services to the company. The corporation deducts this salary as a business expense and it shows up on a W-2 as income to be reported on the shareholders’ personal income tax returns.
  2. Dividends: After paying all business expenses and income taxes, c-corporations can distribute cash remaining in the company to shareholders as dividends. Dividends are not deductible to the corporation, but are taxable to the shareholder that receives them.  This is why people consider c-corporations to have “double taxation.”  Profits are taxed once at the corporate level, and again when paid out as dividends to shareholders.

Salaries and dividends are taxed differently on a personal income tax return, so tax planning opportunities exist in adjusting the mix of c-corporate shareholder salary and dividend payments.

 

How do I get money out of my partnership?

There are two ways for partners to get money out of their business partnership.

  1. Guaranteed payments: Partnerships compensate partners that provide services to the partnership using guaranteed payments. The partnership deducts these direct payments to the partners as a business expense, and the partner receiving a guaranteed reports it as income on her personal income tax return.  The amount of guaranteed payment paid to a partner is usually based on the amount of service a partner provides to the business.  Therefore guaranteed payments can vary widely from partner to partner.
  2. Partner draws: after paying all business expenses, partnerships can distribute remaining funds to partners in the form of partner draws. Partner draws are not deductible to the partnership, nor taxable to the partners receiving them.  While not required, partner draws are generally based on the partners’ ownership percentages in the business. For example, 50/50 partners usually shared equally and partner draws while 60/40 partners would share them in a 60/40 ratio.

 

How do I get money out of my s-corporation? 

S-corporation shareholders can take money out of their corporations in two ways:

  1. Salary/Wages : An s-corporation must pay a salary to shareholders that provide service to the corporation. Usually the shareholders are officers of the corporation.  The IRS requires that the salary provide “reasonable compensation” for the services rendered.  The business may deduct this salary and associated payroll taxes as business expenses and the salary shows up on a form W-2 as taxable income to the shareholder.  It must be reported as income on the shareholder’s personal income tax return.
  2. Distributions: After all business expenses are paid, s-corporations may distribute cash from the business to shareholders. These are appropriately called distributions.  The corporation may not deduct the distributions as a business expense.  Likewise, under most circumstances, they are not taxable to the shareholder who receives them.

 

How do I get money out of my LLC? 

LLCs are tricky animals because they can be taxed in several different ways.  When initially formed, by default, LLCs are taxed as partnerships and LLC members may withdraw money from their LLCs in the format described above in the “How do I get money out of my partnership?” section of this article.  The only difference is that the withdrawals are referred to as member draws instead of partner draws.

The IRS also allows LLCs to elect to be taxed as s-corporations or c-corporations.

LLCs that elect to be taxed as s-corporations pay reasonable compensation in the form of wages to their members in exchange for services rendered, and LLC members may withdraw profits from the LLC in the form of (generally) nontaxable member draws.

LLCs that the elect to be taxed to c-corporations pay their shareholders exactly as c-corporations do using taxable wages or salaries and taxable dividends.

 

Renting from yourself

Some business owners own a building that they rent to their business.  The business takes a deduction for the rent paid to the owner, and the owner claims the rental income on his or her tax return.  This arrangement also allows them to pay the building’s operating expenses out of the business.  This is another way to get money out of your business and take advantage of tax planning opportunities that arise when there are differences in the taxation of the rental income on the owner’s personal income tax return and the taxation of the net business income.

 

Shareholder loans

Corporate shareholders also can take money out of their businesses temporarily in the form of a loan.  This technique is often used for tax planning and must be well documented.  We will address its intricacies in a separate blog post.

 

Conclusion

How you get money out of your business depends on the type of business entity you have.  It’s fairly simple to follow the entity-specific rules once you get used to them, and it’s important to take advantage of any tax planning/tax reduction opportunities that exist in the your specific entity structure.