What is Owner’s Draw in QuickBooks? How Does Owner’s Draw Work?
If you are a sole-proprietor, you may have wondered about the Owner’s Draw account and how it works. I’ll try to explain it in a way that makes sense to people who use QuickBooks.
Owner’s Equity, Owner’s Investment, and Owner’s Draw
If you open the Chart of Accounts in QuickBooks (Control-A), scroll down to the Equity accounts – normally about half way down. You may see one or more of these names: Owner’s Equity, Owner’s Investment, or Owner’s Draw. To make it easier to understand, we’ll say, for now, that the above terms are synonymous. Some accountants reading this may not agree, but I think for anybody who doesn’t understand what they mean, it’s easier to understand them if we use the terms interchangeably.
Here’s what I want you to know about the above terms: they all represent the amount of personal money the owner has put into, and taken out of, the business. Notice the emphasis on the word personal – this means money generated outside of the business’ activities.
Whatever the name, if it has a positive balance, this represents the sum total of personal money put into the business. If it has a negative balance, this represents the sum total of personal money removed from the business.
How much money can I draw out of the business for personal expenses? Is there a limit? Do I pay taxes on that money?
Sole proprietors may draw out as much personal money from the business as they wish, with no tax implications. Taxes are paid based on the profit of the business, not on the money the owner removes from the businesses for personal purposes. A sole-proprietorship is known as a pass-through entity. The profits “pass-through” the business and get taxed at the personal level.
Also, it does not matter how much money the owner originally invested. In fact, it’s extremely common for the owner to draw out much, much, more from the business than he/she originally invested. This is not illegal, and is, in fact, the way the owner pays him/herself for operating the business.
What if I didn’t keep track of personal money I put into the business?
It’s not a problem, in and of itself. But the question is a bit vague. What I mean is that if that sort of money isn’t being tracked, what else isn’t being tracked? For example, when personal money was used for business expenses, that is putting personal money put into the business. If the money is not tracked, why not? Is there no receipt showing where the money came from or, more importantly, which business purpose it was used for? If this is the case, then the expense cannot be claimed on a tax return.
For a sole-proprietorship, and from a tax perspective, it doesn’t matter how the business expense was incurred. Sole-proprietors do not submit their Balance Sheets to the IRS. Remember how the Schedule C is constructed–it is an Income Statement only, which means it only shows the income and expenses. It doesn’t show how the that money flowed into or out of the business, which is a function of the Balance Sheet. The documentation (receipt, invoice, statement, etc.) showing that it was an actual business expense is mandatory. If that is missing, than tax deductions are not permitted to be taken, which raises profit. Undeductible expenses should be posted to Owner’s Draw so that profit is not impacted by them.
How do I record Owner’s Draw in QuickBooks?
Any time you use business funds for personal reasons, you will assign the Owner’s Draw account in the lower half of the screen. I talk a lot about the three purchase windows in QuickBooks (Write Checks, Enter Credit Card Charges, and Enter Bills), but most likely, you only need two of them–Write Checks and Enter Credit Card Charges. You probably won’t ever use the Owner’s Draw account from the Enter Bills window. My view is that it is a bad habit to show personal liabilities on the sole-proprietorship Balance Sheet. There is one concession I make for this and I will explain it below.
Here’s how to record it: from the Write Checks or Enter Credit Card Charges window, record the date, amount, and other information as needed in the upper half of the screen. Then, in the lower half you will see the Expenses Tab. Open the account box and scroll up to select the Owner’s Draw account. This ensures that personal expenses are not deducted from business income.
I want to show the personal money I put into the business as a loan to the business – is this ok?
My normal suggestion is for people show personal money invested in the business as I describe above. Remember: a sole proprietor is the businesses. It’s like loaning money to yourself. That doesn’t make sense, does it?
However, you won’t get in trouble with anybody for showing it as a loan. Remember what I said above about about my concession for personal liabilities on the business books? Since sole-proprietors don’t submit their Balance Sheets to the IRS (unlike other entities), I will concede that the owner may receive a benefit (in the form of useful and desired information) by recording personal investments into the business this way. However, I would prefer that it only happens for the first year or two. If the Enter Bills window is used to record the loan, then the Pay Bills window must be used when the business repays the loan to the sole-proprietor. I describe how those two windows work, and what happens when the first is used but the second is not, in this post: The three purchase windows in QuickBooks.