I converted my sole proprietorship to a LLC and took the S-election effective 3/23/2012. My problem is that because a lot of my annual income was received in the first two months of the year, my expenses plus draws/distributions exceeded income for the period since the LLC/S-corp was created.

Specifically, between 1/1/12 and 3/22/12 the company had income of $66K and between 3/23/12 and 12/31/12 income was $73K. Expenses were $12K and $62K, respectively, and draws were $22.5K and $37.5K.

I don't understand how to set up my initial balances for the LLC/S-corp. Is there a way to offset some of the income received in the first 2 1/2 months by the draws taken in the last 9 1/2 months?

There’s no such thing as an owner’s draw in an S corp. It’s either wages reported on W2 or dividends. Worst case, money drawn can be consulting fees. But that’s not the best idea. If the company has enough money to pay the sh/EE enough to live on, the Sh/EE should be on payroll.. In addition to paychecks they can have distributions to them, but it is non-taxable only as long as their basis in the company is not negative. They should take quarterly distributions so it can be seen that they were not pulling money out of the company instead of paychecks. The distributions should be recorded in an equity account.

In the case of SP and PS, I guess you do not necessarily have to offset some of the income received in the first 2 1/2 months by the draws taken in the last 9 1/2 months; An entry for "owner's drawing" in the financial records of a business represents money that a company owner has taken from the business for personal use. Owner's draws are routine occurrences in small businesses. They don't qualify as business expenses, so do not need to be matched to income/revenue, however. Rather, they are distributions of company profits , much like the dividends that a corporation would pay. An owner's drawing is not a business expense as said above, so it doesn't appear on the company's income statement, and thus it doesn't affect the company's net income.
Sole proprietorships and partnerships don't pay taxes on their profits; any profit the business makes is reported as income on the owners' personal tax returns. Since the owner is going to pay personal income taxes on that money regardless of what happens to it, he's free to take it out of the company at any time.For sole proprietorships and partnerships that keep formal financial records, the owner's drawing appears as a temporary account under owner's equity. Each owner of the business typically has an equity account, or capital account, in the company's books that keeps track of his stake in the company. It's made up of the money he's invested, plus his share of accumulated profits, minus the amounts he has withdrawn. Any money an owner has pulled out of the business over the course of a year is recorded in the temporary drawing account. At the end of the year, the drawing account is closed out, meaning the balance is subtracted from the owner's capital or equity account.