If you’re thinking of organizing your business as a limited liability company (LLC), or have already made the move, one of the most important questions you may have is, “how do I pay myself?”
Well, it depends.
How you pay yourself if you form an LLC can differ depending on whether you are the sole member (owners of an LLC are called “members”) or if your LLC has more than one member.
The IRS also has strict guidelines about how LLC members are paid and how those earnings are reported or classified on your tax return (known as a tax election). By default, an LLC is taxed as a sole proprietorship (if it has one member) or a partnership (if it has more than one member). But you could also elect to have your LLC be treated as an S corporation or C corporation.
If your LLC is taxed according to the default rules the members cannot be considered as employees and cannot receive a salary. However, if you choose to have the LLC taxed as a corporation, the members who actively work for the LLC can be considered employees and can receive a salary.
In this article, we’ll focus on LLC owner payments based on the default classifications, whether the LLC is a single-member or multi-member entity. We will also discuss the consequences if the LLC opts out of the default classification.
Getting paid as a single-member LLC
If you’re the sole member of the LLC, then it’s considered a single-member company and will be taxed as if it’s a sole proprietorship (unless you elect to be treated as a corporation).
However, you are not paid like a sole proprietor where your business’ earnings are your salary. Instead, you are paid directly through what is known as an “owner’s draw” from the profits that your company earns. This means you withdraw funds from your business for personal use.
This is done by simply writing yourself a business check or (if your bank allows) transferring money from your business bank account to your personal account.
Tax requirements for a single-member LLC
It’s important to note that no matter how much you “draw” to pay your salary, your business is still taxed on all its profits for the year.
If you choose not to elect corporation status, the IRS considers the LLC a “disregarded entity.” This means that the business is not separate from the owner and you’d report all your LLC’s profits or losses on Schedule C.
What about payroll taxes?
Well, because you are a single-member LLC, you are not considered an employee of the business. Basically, you are the business. Social Security and Medicare contributions are not withheld. Instead, you must report and pay self-employment taxes as if you were a sole proprietor.
If you elect to have your LLC be taxed as a corporation, then you can be considered an employee. You can receive a “reasonable” salary. Income taxes, Social Security, Medicare, etc. are withheld.
Getting paid as a multi-member LLC
If you are one of the owners of a multi-member LLC, you are treated as if you are a partner in a general partnership. The exception to the rule is if you elect to be treated as a corporation for tax purposes.
Each member has a capital account. To get paid, LLC members take a draw from their capital account. Payment is usually made by a business check. They can also receive non-salary payments or “guaranteed payments” — basically a payment that is made regardless of whether the LLC has generated any net income that month or quarter. This ensures cash flow for each LLC member during unprofitable periods.
Your LLC should have an operating agreement(regardless of whether you are a single- or multi-member LLC). In it you can stipulate how payments are distributed to each member. You can also set forth rules around the distribution payment schedule, if a vote is needed, and so on. You should also reach an agreement with all members on how the company’s profits will be divided — whether evenly or based on ownership percentage, or otherwise. If you don’t provide for these issues in your operating agreement, the default provisions of the LLC statute under which your LLC was formed will govern these matters.
Always consult a tax professional since there are other nuances to how LLC members get paid depending on the services they provide to the business.
Tax requirements for a multi-member LLC
If your LLC is taxed as a partnership, normal tax rules apply to the business. This means that all taxes flow through to the members, and the LLC’s income is taxed on each member’s tax return.
The LLC must report business income and deductible expenses on IRS Form 1065. Then each member will show their share of partnership income on Schedule K-1. Each member must pay income taxes on their share of the profit. Members who actively work for the company must treat their share of the profit as self-employment income.
Can an LLC business owner (member) be an employee?
As noted earlier, members of an LLC cannot be classified as employees if the LLC remains in its default tax status.
However, if the LLC elects to be taxed as a corporation, a member who actively works for the LLC may be considered an employee. The company will pay taxes directly to the IRS, and the members can report all wages, salaries, and dividends on their personal tax returns.
Are there tax benefits to having an LLC taxed as a corporation?
For some LLCs and their owners, being taxed as an S corporationcan provide tax savings — particularly if the LLC operates an active trade or business and the payroll taxes on the owner are high. Electing C corporation tax status can also provide tax savings — particularly if the corporate tax rate is lower than the members’ personal tax rate and/or distributions are not to be made.
A note about pass-through taxation
One of the main reasons that small business owners structure their businesses as an LLC is because it is a pass-through tax entity for federal income tax purposes. This means that the LLC’s gains, losses, income, deductions, credits, and other tax items flow through to the member(s). The LLC is not subject to an entity-level tax unless it chooses to be taxed like a C corporation.
However, the LLC’s pass-through entity status does not mean that there are no tax considerations involved in operating a company as an LLC. While there may not be entity-level income tax liability at the federal level (unless you choose to be taxed like a C corporation), a multi-member LLC must still file an information report. In addition, the LLC may be liable for other types of taxes and may be required to file various returns with state and local governments.
Learn more: How to form an LLC
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