Understanding the Difference Between Distributions and Payroll

There’s nothing more exciting than starting a business and then growing it from nothing to the point where you’re able to pay yourself a salary. The fact that you’re researching this topic leads me to believe you’ve achieved something worth celebrating. As exciting as it is to finally reach this stage of your career, it’s also important that you make the right choices early on.

Most business owners who own LLCs or Sole Proprietorships need to worry less about this issue. As the owner of one of these types of businesses, you have the right to take a “draw” from your business as long as the money is accounted for. However, in larger companies (specifically S-Corporations) business owners are required to pay themselves in two very specific ways. 

When a company makes a profit, meaning they made more money than it cost to operate the business, they can choose how to allocate those funds. Often they are reinvested into the company, and in the case of S-Corporations money can be distributed back to the company’s owners or stockholders in the form of tax-free distributions. 

Some business owners make the mistake of confusing distributions with payroll

This can cause an IRS nightmare and invite unwanted audits. Owners and shareholders who work in the company must receive reasonable compensation for their work. Factors that determine what reasonable compensation should be include training and expertise, responsibilities, work time, and more. It’s reasonable to assume that companies that have unpaid or underpaid shareholders and owners are shirking the payroll tax requirement set by the IRS.

Before you start worrying about the details, know that we are here to help you navigate these waters. If you don’t have a team of expert accountants working with you on matters like this it's time you gave our office a call. For the reasons mentioned above and many more, it’s extremely important how you set up your company. As you see, the financial rules and regulations vary greatly depending on the type of company you own. If you’re in the beginning stages of this process, confer with a licensed professional to ensure you set your business up properly the first time.

At Fix-It Accounting, we specialize in fixing the complicated issues that come up when people come in contact with the IRS. We’re good at fixing problems, but for your sake, we’d much prefer to help you from the beginning so you don’t encounter problems, to begin with. If you have questions about how to get paid from your business, contact our office today. It would be our pleasure to help.