A limited liability company (LLC) is a useful structure for small businesses. It offers liability protection for LLC owners, who are also known as members, without the complexity and formalities of a corporation.
One of the most common queries from small business owners setting up limited liability companies is, "How do I pay myself from my LLC?"
An LLC can help to structure your personal finance, but it is important to know how to pay yourself as an LLC owner. This article explores how to pay yourself in an LLC, evaluating how to structure business operations for your own tax purposes.
How do you pay yourself from an LLC?
A limited liability company is a simple business structure for a small business owner to manage. There are no requirements for annual meetings, minutes, orissuing stock certificates. You can decide how you want to run your business and how to distribute business profits and losses. You can also choose how to pay yourself in an LLC to optimize your personal income tax return and personal finance.
But there are some disadvantages to operating small businesses as LLCs. The first is the possibility of limited life. An LLC formed in states that do not allow perpetual life willdissolve as a business entityupon the death or disassociation of an LLC member.
A small business owner may also have topay self-employment taxeson their share of the LLC's net income unless they decide that the LLC will pay tax as a corporation. These self-employment tax payments might be higher than those paid by employees.
Limited liability companies offer financial flexibility because, as a member, you can choose its legal designation for dealings with the IRS. Single-member LLCs are treated assole proprietorships, but an LLC can also have more than one member. Multimember LLCs are partnerships by default.
How do I pay myself from my LLC?
So how do you pay yourself in an LLC? There are various options for small business owners.
How to pay yourself LLC income through an owner's draw
Aspass-through entities, multimember LLCs do not pay corporate taxes. Instead, the tax is the personal liability of the business owner. The same is true for a sole proprietor, single-member LLC owner.
When deciding how to pay yourself in an LLC, consider taking distributions of business profits each year as personal assets. Each member owns a percentage of the LLC. Year-end distributions of an LLC's profits are made based on that percentage from the business account. So if the LLC had $100,000 in profit and you and the other member each own 50%, you can each receive $50,000. This would appear on your personal tax return.
Owner's draws come from a business account set up for an owner when the company is formed. This account holds their initial contribution to the small business and amasses their share of the LLC's profits. The business entity can set the frequency of payments in its operating agreement.
If you expect your percentage of the year-end LLC profits to be $12,000, you could set up a draw to receive $1,000 each month as personal assets from the business bank account. The total of all the draws throughout the year is deducted from the total year-end profit. So if your draw for the year totaled $12,000, but your share of the profit ends up being $15,000, then you would receive $3,000 at the end of the year.
To pay yourself LLC income through an owner's draw, write a check from the LLC to the business owner's personal account. Record the withdrawal as an owner's draw, along with the appropriate debit in the owner's business account. This periodic payment eliminates the need for payroll taxes and forms.
The LLC need not withhold taxes on distribution payments, meaning there are no W-2 or W-4 (employee withholding) forms to deal with. Instead, you will report your share of the business income on your personal tax return and pay income taxes and self-employment taxes on it.
Regular owner's draws are effectively a pre-payment of profit, but you can also pay yourself LLC funds in the form of a guaranteed payment. These occur regardless of any LLC profits, making this arrangement more like a salary. Unlike an owner's draw, guaranteed payments are deductible business expenses for your LLC, reducing its taxable income.
Members of an LLC taxed as a C corporation (C corp) or an S corporation (S corp) cannot make an owner's draw. Instead, the LLC can pay them a reasonable salary. Paying yourself from an LLC as an employee comes with some advantages. It allows you to receive regular reasonable compensation that you can plan on throughout the year, which can be helpful if you are seeking a regular income. Paying yourself LLC wages requires working in the business and filling a role with real responsibilities.
The advantage of paying yourself as an employee of a C corp or S corp is that you can reduce your liability for self-employment taxes by paying yourself a reasonable salary and taking some more of your LLC profits as dividends. The IRS defines reasonable salary as the amount someone doing similar work would receive in the same industry and location. If you fail to pay yourself reasonable compensation, the IRS may challenge it and reclassify some of your dividends as employee wages, which would increase your self-employment taxes. An LLC member who is an employee can take a bonus, but this must also be reasonable relative to their salary.
The disadvantage of paying yourself as an employee of a C corp or S corp is that you have to comply with various LLC payroll tax requirements, such as filing Form W-2, Form 941, Form 940, and state and local payroll tax returns. You also have to pay the employer's share of Social Security and Medicare taxes, federal unemployment tax (FUTA), state unemployment tax (SUTA), and workers' compensation insurance for yourself and any other employees of your LLC.
It's important to note that receiving a salary and receiving year-end distributions are not mutually exclusive. If you get a paycheck, you're still a member of the LLC and entitled to your year-end distribution.
Yet another option for LLC members to pay themselves is to hire themselves through the company. This arrangement allows you to be an independent contractor as an LLC owner.
For example, a member of an LLC who prints signs can also hire herself as an independent contractor to do the graphic design for the signs. This type of arrangement may not offer as many benefits, though.
If you choose to pay yourself as an independent contractor, you must file IRS Form W-9 with the LLC. The LLC then files IRS Form 1099-MISC at the end of the year.
LLC members can also take a loan from the business. This option allows the members to access cash without affecting their tax liability. However, the loan must be documented and repaid with interest, according to the LLC's operating agreement.
You also have the option to not pay yourself anything and to leave the profits in the LLC. You still need to pay income tax on the profit earned, since the profits from your LLC pass through to your personal bank account.
How to handle income tax on LLC pay
An owner's draw taken from a multimember LLC or a single-member LLC does not affect the income taxes you pay on your total share of the profits. Owners in an LLC owe income tax on the amount their capital account amasses from the year's profits, regardless of how much they draw that year.
This means you owe income tax on your share of the LLC's profit—known as your distributive share—whether you draw it or not. So, if you leave some money in the business, perhaps to cover expansion costs, you are still liable for personal income tax on that amount.
Unlike with payroll in a C corp, an owner's draw is also not considered a deductible business expense for an LLC by the IRS, meaning it cannot be claimed against corporate tax.
Both sole proprietorship and multimember LLC entities can elect to pay corporate taxes as corporations, if they prefer, through the filing of a Form 8832 with the IRS. However, it is important to consider the tax implications of this legal structure.
A C corp is double-taxed. It must pay income tax to the IRS, and those taking wages or dividends from it also pay personal income tax on those earnings.
While a C corp LLC can be disadvantageous for those drawing regular income, it can be a useful structure for higher net-worth members planning to leave capital in the business. C corp taxation rates are often lower than the higher-level personal tax rate, creating an opportunity for tax savings.
Qualifying multimember LLCs can also designate themselves as an S corp. An S corp is a pass-through entity and does not pay taxes at the federal level. To qualify as an S corp, an LLC must be a U.S.-based business and cannot have more than 100 owners. Neither can an S corp have a corporation or partnership among its members or carry multiple stock classes.
If you choose to pay yourself a salary from your LLC as an employee, you will pay income tax on your wages earned, and the LLC must file a W-2 form to show the IRS your payments and withheld taxes. You'll need to file IRS Form W-4 to determine the amount of income tax that the LLC should withhold from your paychecks. This will also incur LLC payroll taxes.
One advantage of paying yourself a salary as a member is that wages are considered operating expenses for the LLC, enabling members to deduct them from the LLC's profits for tax purposes. The IRS only allows reasonable wages as a deduction for corporate tax.
Multimember LLC and single-member LLC status
Each member of a partnership multimember LLC pays a portion of income tax on its earnings, whether they draw it or not. The partnership must give each member an IRS Schedule K-1 (1065) detailing their share of the business income. The LLC will also file Form 1065 to report partnership income to the IRS.
If all of the LLC members in a multimember LLC participate equally in the operation of the business, you can't pay one a salary and not the others. However, if you are the only member that has a management role, you can pay yourself a salary without setting up salaries for the other participating LLC members.
How to pay yourself single-member LLC income
Single-member LLCs are not taxed. Instead, the sole member reports the income and expenses of the business on Schedule C of their IRS Form 1040 tax return.
Self-employment taxes
Typically, a company pays half of an employee's taxes (known as FICA taxes) that contribute to Social Security and Medicare. The employee pays the other half.
LLC owners not considered employees must pay the half of the FICA taxes that would normally be paid by an employer. This taxation applies to their entire distributive share, although as self-employed people they can generally claim half of the self-employment taxes they pay as a business expense to make some tax savings.
Members of C corp LLCs get half of their FICA taxes paid by the LLC but must cope with the double taxation issue. Alternatively, S corp LLCs avoid double taxation while also paying their half of the employee member's self-employment tax.
Members working as contractors must pay self-employment taxes on the contractor fees from the LLC.
Self-employment taxes only apply to active members who participate materially in the operation of an LLC. Passive members, who don't participate, don't pay this tax.
