First things, first. Make sure you have your business funds separated from your personal funds. Have one bank account for your business transactions (all income and expenses) and one bank account for your personal transactions. When you pay yourself, you will pay yourself from the business account to your personal account.
Next, we need to talk about your business entity. How you are set up determines if what you pay yourself is considered a business expense.
You have a business, and you are the only one that owns it. There’s not much to it when you pay yourself as a sole proprietor. You are taxed on your net income (income minus expenses), and it doesn’t matter how much of that net income goes to your personal bank account. The money you pay yourself isn’t considered an expense or a cost – it is a draw. You would reduce your cash account (credit) and reduce your equity account (debit).
Single member LLCs
A legal entity taxed the same way as sole proprietors, but again, make sure you keep your business and personal transactions completely separated!
A business with two or more owners. Partners report their share of net income on a K-1 and will pay tax on that amount. Partners are not considered employees of the company and therefore are not paid a salary – they would take a draw from the company. Unless it’s a guaranteed payment, in which case it is a business expense, but as the partner you will be paying income and self-employment taxes on that.
A special election has to be made to be treated as an S-Corporation. The company can pay W-2 wages to its owners. These wages are also an expense you can deduct. As long as you are paying yourself a reasonable wage, you can take distributions from the business on top of that. Distributions in an S-Corporation are treated like draws, they hit the balance sheet, not the income statement.
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