Salary vs distributions: how money leaves your practice

Money leaves your practice for you in one of three ways: salary through payroll, a distribution or owner draw, or paying you back for a business expense. Each one is recorded differently and taxed differently, and mixing them up is one of the most common messes I clean up.

The three ways out

• Salary. You're on payroll, taxes are withheld, and you get a W-2. It's an expense on the P&L. This applies if your practice is an S corp or a C corp.
• Distribution or owner draw. A transfer of the practice's money to you. It isn't an expense, so it doesn't lower profit. It comes out of your equity on the Balance Sheet.
• Reimbursement. The practice pays you back for business costs you paid personally, with receipts. Each expense is recorded in its category. Here's how an accountable plan handles it.

Which applies to you

It depends on how the practice is taxed.

• Sole proprietor or single-member LLC with the default setup: you can't put yourself on payroll. You take owner draws.
• S corp: you take a salary through payroll and can take distributions on top of it.
• Partners: the rules differ again, so ask your CPA how your payments should be set up.

Why draws don't lower your taxes

This one surprises a lot of owners. With a sole proprietorship or an S corp, the profit is taxed on your personal return whether you take it out or leave it in the bank. Taking a draw or distribution doesn't add tax, and leaving the money in doesn't save any.

So a year with $90,000 of profit and only $40,000 in draws still has $90,000 of taxable profit. Plan your tax set-aside on profit, not on what you took home.

S corp distributions have rules

If the S corp has more than one owner, distributions have to follow ownership percentages. And if distributions run larger than your stake in the company, they can become taxable in a different way. Your CPA tracks that stake, called your basis, each year.

A rhythm that works

I'd set it up like this:

• Salary on the regular payroll schedule, if you're an S corp.
• One distribution or draw on a set day each month, after bills, your reserve and your tax set-aside. This post walks through how to find that number.
• One reimbursement each month for business costs you paid personally, with receipts attached.

Make each one its own transfer from business checking to your personal account, with a memo that says what it is. Don't pay personal bills straight from the practice account. Here's why that matters.

Common questions

Are distributions taxed?
The practice's profit is taxed on your personal return whether or not you take it out. In the usual case, the distribution itself doesn't add more tax. Your CPA can confirm for your situation.

Can I take money out if the practice lost money?
You can move the cash, but it can create tax problems, especially in an S corp. Ask your CPA before you do.

Can I put myself on payroll as a sole proprietor?
No. A sole proprietor or single-member LLC with the default setup takes owner draws. Payroll for yourself starts with an S corp election.