Expert: Shirley McAllister, CPP, PHR - 2/20/2009

Question
I am unfamiliar with the term 'Owner's Draw'.  Small LLC - the owner took zero salary and Owner's Draw of $200,000.  The wife was on payroll for a month, took salary of $10,000 and Owner's Draw of $50,000.  Both over 50 and made 401(k) of $20,500.  Does that work?  Can Owner's Draw be treated as salary, or did they exceed their maximum allowable 401(k)?

Answer
The 401K has not been exceeded.  The limit for 2008 was 16,500 plus a 5,500 catchup amount allowed for those over 50 which would be 22,000 total allowed for 401K.

owners of LLCs are considered to be self-employed. Self-employed owners of LLCs generally are not issued payroll checks with tax withheld. Instead, the self-employed owner of an LLC takes money out of the company in the form of an "owner's draw."

For income tax purposes the owners are charged with recognition of their  LLC's profits regardless of their draws. Tax recognition and flow of money are two separate things in an LLC.

Example:

If the LLC made a $20,000 profit, then it is reported through their Schedule C. they DO NOT report that same $20,000 a second time due to the fact that they withdrew it during the year as the owner's draw.

The owner’s compensation should be debited to the Drawing account.

The journal entry to close the drawing or withdrawal account of a sole proprietorship includes a debit to the owner’s capital account and a credit to the drawing account.

To illustrate the closing entry, let’s assume that at the end of the accounting year the account Eve Jones, Drawing has a debit balance of $24,000. This balance is the result of Eve withdrawing $2,000 per month from her sole proprietorship for her personal use. (Each monthly withdrawal was recorded with a debit to Eve Jones, Drawing and a credit to Cash.) The journal entry to close the drawing account requires a credit to Eve Jones, Drawing for $24,000. The other part of the entry is a debit of $24,000 to Eve Jones, Capital.

The drawing or withdrawal account is a temporary owner equity account, requiring it to be closed at the end of the accounting year. The drawing account is also a contra account to owner’s equity, because the drawing account’s debit balance is contrary to the normal, expected balance for an owner equity account.

Also note that the drawing account is closed directly to the capital account. The drawing account is not an expense and as a result it does not get closed to the Income Summary account.

I hope this helps.

Shirley