You’ve likely heard of distributions related to your business, maybe in conversation with your accountant, among other business owners, or on your tax paperwork. Distributions are crucial to growing your business and key in determining small business owner salary, yet many business owners don’t know how to make or use distributions.
In this guide, you’ll explore what a small business owner salary is, as well as distributions; how to make them, and how you should be using them.
Why do you need distributions?
Distributions are used to pay business owners their share of their business’s profits and earnings. You might be taking a distribution and not even realizing it, instead referring to it as your pay or salary.
Knowing the concept of distributions and how to make them can help you take as much financial reward from your business as is reasonably possible.
Where can I find distributions on my financial statements?
Although it seems like your small business owner salary should be an expense that’s listed on your profit and loss statement, distributions are actually listed on your balance sheet. This is because distributions have no effect on your business’s profitability or the amount of taxes your business will pay.
Distributions are made to business owners by taking cash out of the business from retained profits or cash that investors put into the business. You’ll see it show up on a cash flow statement or a balance sheet, but not a profit and loss statement. When it’s time to prepare tax returns, distributions show up in two important places:
- On the business side, distributions show up on the balance sheet section of your tax return (total distributions since the business started) and in Section M-1, which shows distributions that have been made throughout the year.
- For business owners, distributions and dividends show up on the form K-1 that you receive from your business. This document is used to prepare your personal taxes.
What’s the difference between a distribution and a dividend and who can receive them?
Most small businesses are limited liability companies (LLCs) or S-Corps and aren’t likely to have dividends. Distributions are a payout of your business’s equity to you and other owners. That means they can come from the accumulated profits or from money that was previously invested in the business, and they’re not factored into how much you’re is taxed.
Dividends come exclusively from your business’s profits and count as taxable income for you and other owners. General corporations, unlike S-Corps and LLCs, pay corporate tax on their profits. Distributions that are paid out after that are considered “after-tax” and are taxable to the owners that receive them.
Any legitimate shareholder or LLC member is eligible to get distributions. Generally, any time distributions are paid, everyone who is eligible to get them must get their share. That means in a four-equal-partner business, for one partner to receive $1,000 in distributions the business must pay out $4,000 in total with $1,000 going to each of the four partners.
How much can my business pay in distributions?
Choosing how much to pay in distributions can be as complicated or as simple of a choice as you want. On the most basic level you can follow these rules:
- Pay less in distributions than your business made in profits in a period.
- If your business is not profitable, don’t pay any distributions.
- Even if you have profits to pay out, make sure you hold on to permanent working capital, or a cash reserve.
Breaking any of the above rules can put you in a difficult position if you end up needing a loan to grow your business, which most businesses eventually do. If a lender discovers that you’re paying more in distributions than the business’s profits should allow, or if you aren’t holding on to a cash reserve, you could be placing your business at risk of being denied for a loan.
On a more advanced level, the way that your business pays out distributions might be set in your charter documents (bylaws or an operating agreement). Generally, the rules above still apply but charter documents get much more specific about:
- How to calculate your profits that are available to pay out in distributions
- How much to reserve for any corporate, state, or local taxes
- How much permanent working capital reserve your business needs
- How much to hold onto to build permanent working capital
- How often distributions are paid (usually quarterly or annually).
- The use of accelerated distributions – distributions that are paid at a faster rate to some investors or owners as an incentive for them to be part of the business.
Ask your accountant for advice on distributions
Distributions are something that you should be aware of as a business owner and should know enough about to be able to pay throughout the year. That being said, you’ll likely want your accountant’s advice and insight, too. An accountant can help you determine the following:
- How much of the payments made out each year can be counted as distributions
- How to make sure each owner’s capital account is adequately maintained
- How to make other payments from your business, like salaries or guaranteed payments, that might be more effective for tax purposes.
Be patient with your business’s distributions
There are many reasons why you might want to own your own business. The appeal of being one’s own boss is powerful, and once your business is profitable, taking distributions can be quite lucrative.
However, patience is a key ingredient to business success. It may take a year or two before your business is profitable enough for you to even be able to take a distribution. If you wait until the time is right to begin taking distributions, you’ll experience the profitable benefit of owning a business, while still maintaining your business’s solid financial footing.
Pursuit has financing available to help your business grow
Pursuit is a leading small business lender throughout New York, New Jersey, Pennsylvania, Connecticut, Illinois, Nevada, and Washington. We have a line of credit and loan options that can help you meet your business needs and support growth projects.
Contact us to learn more about how we can help you grow your business.
