How Company Owners Are Paid: Legalities and Considerations
Understanding how company owners are paid, whether this involves taking money directly from the company’s bank account or if it is legal, is crucial for compliance and tax purposes. This article delves into the various methods of payment, their legality, and the importance of proper record-keeping and tax filings.
What Are the Payment Methods for Company Owners?
Company owners have two primary sources of income from their business: a salary and drawings. A salary is similar to any other employee, whereas drawings are the profits that a business owner extracts as compensation.
Common Payment Methods
For small business owners, it's common to treat the company account as their personal account, leaving it to the accountant to handle any discrepancies. As long as all personal expenses are considered salary or drawings and are accounted for properly, with the appropriate tax paid, there is no issue.
Legal and Economic Implications
It is not illegal for a company owner to take money directly from the company's bank account, as long as the owner can demonstrate that the payments are for personal expenses or are properly categorized as drawings. However, there are situations where this practice may not be acceptable.
When It May Not Be Acceptable
If a company owner is taking money from the company without sufficient profit to cover the drawings, it may be treated as a loan from the company to the owner. In the event of the company's bankruptcy, the owner might be required to repay these funds to other creditors.
Historical and Personal Insights
I remember my grandfather who owned a small store in the 1920s through the 1940s. He simply took money from the cash register, but this would not be a recommended practice today. Modern tax laws and regulations require more stringent record-keeping and transparency to ensure compliance.
From my personal experience, as half owner of a technical publication service business in the San Francisco Bay Area, the payment method was straightforward. If the owner worked, they received a wage or salary based on agreed-upon terms. As a sole owner, I could simply withdraw cash from the company’s bank account as needed. Similarly, in a partnership, we would distribute excess funds at the end of the year according to our ownership percentages.
Example of Company Ownership and Management
In another instance, I worked for a pest-control service owned by a retired couple. They likely received direct payments from the company's bookkeeper or manager, as these profits served as their retirement income. In essence, if someone has legal ownership of a business, they may take or request payment from the company's bank account based on their ownership stake.
Legal and Tax Compliance
While taking money from a business is legal and common among proprietors and partners, it is crucial to remember the importance of reporting the income to the IRS and state income tax offices and paying the appropriate taxes. Failing to do so would constitute tax evasion, which is illegal.
Use of Company Profits
Another aspect of business ownership is the option to leave the majority of the cash value in the company for reinvestment and growth. This approach to accumulating business value, known as "unrealized income," can be used by owners to potentially defer taxes until the sale of the business, as detailed in the book "The Millionaire Next Door."
Conclusion
Understanding the payment methods and procedures for company owners is essential for maintaining legality, ensuring tax compliance, and managing personal finances effectively. By adhering to proper record-keeping and tax reporting, business owners can protect themselves from legal and financial repercussions.