Owner Draws. Distributions. Dividends. Bonuses. Oh My!
Historically, business owners pull money out of their business at year-end. They have many reasons for the timing but often wait to see what their bottom line will look like before they take money out. Sometimes, they want to give themselves a holiday gift for all the hard work they have put in during the year. If they are an S-Corp or C-Corp, they may be wanting to pay themselves a bonus to reduce taxable income to the company or the flow-thru (remember, sole proprietors and LLC’s do not pay bonuses to reduce company income). If they are a C-Corp, they may also consider giving distributions.
If you are confused about your pay, see our blog on this. There are also a couple of things to consider when deciding if and how much to pay.
If you don’t have the cash, DO NOT do it! Just like employee bonuses, you shouldn’t pay if you don’t have the funds.
Look at your operating agreement. If you have multiple owners, usually draws or distributions have to be taken out according to a select formula. Make sure you follow this. If you are a C-Corp, distributions must be made to all shareholders based on ownership and the agreement.
If you are an S-Corp or C-Corp, be sure you are taking a salary, and make sure you are paying reasonable compensation in case the IRS audits you. There must be reasonable compensation paid through payroll. Not everything you pull out of the company can be a draw or a dividend. Talk with your tax CPA if you are wondering if you are taking enough to avoid an issue.
For S-Corp and C-Corps, a bonus may also be paid through payroll. Make sure you look at the tax implications of this to calculate how much.
Setting aside the cash throughout the year for bonuses and draws makes it easier to see if you have the funds to pay right now. Also, look at your obligations in the first quarter of the next year. It is often a slow time for many businesses, and having a cash reserve can ease the stress and ensure you can meet your obligations. Our clients using the Profit First System have an account specifically allocated for profit distributions (whether draws, dividends, or bonuses).
Haven’t set aside cash yet? There is still time! Start now by putting a percentage of your income aside to save for year-end payments. Unless you have some huge project getting paid in December, if you don’t have the majority of the cash now, you likely will not have it at year-end.
Look at your cash balance comfort level. If you can’t sleep at night with less than six months of expenses in the bank, then do not spend it all at year-end. Remember, you can also take draws and distributions (and bonuses) anytime. There is nothing that requires you to take it in December. We encourage our clients following the Profit First System to take a prescribed amount out quarterly.
Do not wait until December to decide how much to pay yourself. Make those decisions now, plan ahead and let us know if you need any help!