In tax terminology, the term “draw” refers to money taken out of a sole proprietorship by the proprietor, or out of a partnership by a partner.
Draws are not tax deductible in either scenario, but there are some nuances between draws from a proprietorship and draws from a partnership.
Sole Proprietor Draws
Draws are not tax deductible. In fact, money taken out of a sole proprietorship by the proprietor is essentially a “tax nothing.” It does not get reported on the proprietorship tax return and has no effect on the proprietor’s personal return.
Draws from a partnership are also not tax deductible. However, draws by a partner do need to be tracked because draws reduce a partner’s basis in the partnership.
There are two ways draws play into basis.
One, as previously mentioned, is: draws reduce basis.
Two: if a partner receives draws in excess of his or her basis, the draw becomes taxable.
Basis is important to know in general, especially for down the road when the partner sells his or her interest in the partnership, or the partnership closes.
For more tax terms, visit the Glossary page on this site.