For many small business owner-operators of s-corps, understanding the differences between officer payroll and owner/shareholder distributions can be challenging. We have coached and consulted with many small business owners where this issue has arisen. One way the issue shows itself is in a statement from the owner like “my P&L statement indicates great profits, but I have no money in the bank”. One cause of this, among several possibilities, is that the owner is taking money from the business via distributions (aka draws). These distributions are not an expense recorded on the P&L (aka income statement). They are recorded on the balance sheet. Therefore, the profit or loss of the business is not affected by distributions. Officer payroll (aka compensation of officers or owner payroll) is a recorded expense and will affect the profit or loss of a business. Further, distributions are not subject to payroll taxes, officer payroll is.
The owner-operator of a s-corp should understand these 2 roles. As the owner/shareholder, you are allowed to take distributions that are not subject to payroll taxes. As an operator, you are an employee of your business and should be paid a salary that is subject to payroll taxes. This payroll will generally show as “compensation of officers” on tax forms. The taxing authorities look closely at this ratio of distributions vs compensation of officers. Taking money through the distribution channel can save on payroll taxes, but taking too much money through this channel can be dangerous. We encourage you to visit with your CPA on this issue. As with a lot of tax law, it can be a bit murky.
Understanding financial statements like cash flow, P&L and balance sheets is integral to the success of small business. This understanding is part of The Optimum Solution created by Conder Business Solutions.
Do you need help in understanding your financial statements? If so, contact us today for a free initial visit.