On a recent episode of Small Business Celebration, we had the pleasure of speaking with Dennis Tolliver, owner of Tolliver Bookkeeping and Tax. Dennis shared invaluable insights from his journey as a newspaper sports writer to a successful CPA and business owner. Among the many topics we covered, one key discussion stood out: the differences between a draw and a distribution in business financial management.
For many small business owners, the terms “draw” and a “distribution” can be confusing, especially when it comes to taking money out of the business. As Dennis explained, while both terms relate to the process of withdrawing funds from your business, they are not always interchangeable and depend on the business structure.
Sole Proprietor: Taking a Draw
If you’re a sole proprietor, when you take money out of your business, it’s referred to as a “draw.” As the sole owner of the business, the income generated by your business is essentially your income. When you take money out, you are drawing from the profits of the business. This draw is not subject to payroll taxes because, in the eyes of the IRS, the business and the owner are the same entity.
S Corporation or LLC: Taking a Distribution
On the other hand, if your business is structured as an S Corporation or an LLC, the funds you withdraw are considered a “distribution.” These types of business entities are legally separate from the owner. As such, when you take money out of an S Corporation or LLC, you are not simply taking a draw from your business profits—you are taking a distribution of the earnings allocated to you as a shareholder. Unlike a draw, distributions are subject to different tax rules and are generally not considered payroll income, meaning they are not subject to payroll taxes.
The Importance of Business Structure
Dennis emphasized how understanding the structure of your business is crucial when deciding how to take money out. The structure affects not only the terminology but also the tax implications of your withdrawals. For example, an S Corporation requires a set of financial statements including a balance sheet, making the accounting more complex than a sole proprietorship. This additional complexity is necessary because the IRS views the corporation as its own entity, separate from the owner.
Practical Tips for Deciding Between a Draw and a Distribution
One of the key takeaways from our conversation with Dennis is the importance of proper planning and regular consultation with a trusted advisor. Whether you’re considering transitioning from a sole proprietorship to an S Corporation or simply trying to understand the best way to manage your business finances, working with an experienced accountant like Dennis can make all the difference. Regular meetings and tax planning can help you avoid surprises and ensure you’re taking advantage of the most beneficial tax strategies for your business.
In summary, while a draw and a distribution both involve taking money out of your business, they are distinct concepts depending on your business structure. Understanding these differences and consulting with a knowledgeable CPA can help you make informed decisions to benefit your business in the long run.
For more insights from Dennis Tolliver and other successful small business owners, be sure to tune in to the next episode of Small Business Celebration. Whether you’re just starting out or looking to grow your business, there’s always something new to learn from those who’ve walked the path before you.
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Reach out to our guest’s website: Tolliver Bookkeeping & Tax