Paying yourself from an LLC can be a complicated process, but it doesn't have to be. In this post, we will explain how to pay yourself as an LLC in any case scenario and give you some tips for avoiding legal trouble when doing so.
The way you pay yourself from your LLC will differ depending on what type of business entity your company is.
Why Is It Good to Have an LLC?
Limited liability companies protect the personal assets of their owners and provide personal liability against business debts.
An LLC is not taxed like a traditional corporation but as its own separate entity and pays no income tax at the company level. The owners of an LLC must pay taxes on their percentage share of profits from the business each year they receive those profits or losses when they withdraw money from the company.
As pass-through entities, they provide the same liability protection as a sole proprietorship or partnership.
An LLC can choose to be taxed like an S-corporation, but this is not common and should only be done if it fits the company's specific structure and goals.
This means that you will pay taxes on your personal income tax returns instead of filing another tax return for the LLC.
When you pay yourself from an LLC, it is important to remember that all distributions of the company's profits and losses must be reported.
The salary members get will depend on the type of the LLC, their ownership percentage, and taxed as self-employment income.
Single-Member LLCs
A single-member LLC is a business entity that has only one sole owner.
That single member is called a "member," and the entity is legally known as an LLC (limited liability company).
More than half of all small businesses in America are formed as LLCs, including most sole proprietors who operate their business on their own without employees or other partners.
Paying yourself through a single-member LLC can take place in two ways:
- You can pay yourself a salary on an owner's draw (like a sole proprietor)
- Or, you can take distributions from the LLC's earnings and profits like an S corporation.
Distributions are not considered taxable income for sole members of single-member LLCs until they reach certain limits set out by the IRS that have been adjusted upwards annually.
When a business generates enough annual distributions and LLC profits, it pays off to choose S corp taxation. For the majority of LLCs, the default option is the best.
Paying Yourself as a Sole Proprietor (Default)
A single-member LLC is taxed in the same way a sole proprietorship is. It means the owner reports the business income on a personal tax return, i.e., Schedule C, and then has to pay self-employment tax when filing his or her Form SE.
It is important to understand that this does not mean the LLC itself must pay taxes since it's an artificial legal entity created by state law, and it's not connected to its owner in that sense.
Single-member LLCs pay themselves a distribution, not a salary. Small business owners can take distributions at any time by simply writing themselves a check for the amount they want to withdraw from the company coffers.
Distributions, however, are subject to self-employment tax in much the same way as an LLC's net income is.
This represents the perfect example of pass-through taxation. The LLC is not taxed at the business level since it's a single-member LLC.
Instead, income passes through to its owner's personal income tax return on his or her share of profits.
Small businesses can benefit from this type of taxation election because it simplifies tax procedures and reduces the recordkeeping required.
However, it would be best to be careful not to distribute funds above what would normally pass through as net income since this will result in double taxation and potentially disrupt your corporate veil.
Paying Yourself through an S Corporation (Elected Status)
An S corporation does not represent a business structure. It is a taxation method for limited partnerships and limited liability companies.
By electing to be taxed as an S corporation (See the difference between an LLC and an S corporation), all profits are funneled through each member's personal income taxes instead of the business' corporate tax structure.
This is beneficial for LLC members who do want to pay themselves a salary but don't want to incur self-employment taxes (social security and medicare) on their share of earnings.
S corp owners report their salary on their personal tax returns.
The salary represents the member's pro-rata share of S corporation income, which is then taxed at an individual rate. The FICA taxes (federal payroll tax) are automatically withheld from each paycheck.
An S corp election is ideal for those businesses that can generate enough profits to cover their salary and an additional amount for the company.
This method is not ideal if members take such large distributions that there isn't enough left over to pay themselves a reasonable salary.
Read more: How to File Business Taxes for an LLC?
Paying Yourself through a C Corporation (Elected Status)
A C corporation differs from an S corp in that it is taxed as a separate entity and its owners (known as shareholders) are subject to double taxation.
Shareholders must pay taxes on any dividends distributed, or they can elect for the corporation to retain earnings in the company, which will be taxed later when those funds are distributed as dividends.
C corps report their wages from a W-2 on their personal tax return. FICA contributions will be deducted immediately from the pay.
That means that a C corporation must pay corporate taxes on its net earnings and that the dividends paid to shareholders are included in their personal income taxes.
To put it another way: Dividends from C corporations are taxed twice - once by the corporation as part of its profits at a rate equal to your marginal tax bracket plus the additional Medicare surtax on investment income.
A C corporation is ideal for those businesses that want to attract investors or want to be traded on the stock market because the investors can receive dividends and capital gains.
Multi-member LLCs
A multi-member LLC represents two or more people who have joined together for a business purpose. The LLC is taxed as a partnership, which means that the company files tax returns and pays taxes on net profit at their personal income rates.
Each member of the multi-member LLC will need to decide how they want to be paid by the company. It is typical for members of an LLC to pay themselves a salary as well as take distributions since they both have different tax consequences.
A multi-member LLC must also decide how the profits will be distributed among each member and what percentage of ownership each person has in the business.
These provisions will have to be specified in the operating agreement (partnership agreement).
LLC owners in a multi-member LLC are taxed as partnerships, so each LLC member files taxes on an individual income tax return through what is known as pass-through taxation. Members pay income tax on their draw and pay self-employment taxes too.
This business structure is ideal for those businesses that will have multiple people providing services or working in the company.
Multi-Member LLC Taxed as a Corporation
Multi-member LLCs can also choose to be taxed as an S or C corporation.
When an LLC elects to be taxed as an S corporation, business owners pay income taxes and FICA self-employment contributions on their reasonable salaries.
Tax savings must be weighed against the payroll and accounting services costs necessary to keep the S corporation's status.
Members of LLCs that are taxed as C corporations pay both FICA and income taxes on their reasonable compensation, but any dividends are only subject to income taxes.
Unlike S corporations, which are taxed separately from the corporate entity, the C corporation itself is taxed on the entire business profits.
An S corp election is ideal for those businesses that can generate enough profits to cover their salary and an additional amount for the company. This method is not ideal if members take such large distributions that there isn't enough left over to pay themselves a reasonable salary.
Paying Yourself through a C Corporation (Elected Status)
A C corporation differs from an S corp in that it is taxed as a separate entity and its owners (known as shareholders) are subject to double taxation.
LLC shareholders must pay taxes on any dividends distributed, or they can elect for the corporation to retain earnings in the company, which will be taxed later when those funds are distributed as dividends.
C corps report their wages from a W-2 on their personal tax return. FICA contributions will be deducted immediately from the pay.
That means that a C corporation must pay corporate taxes on its net earnings and that the dividends paid to shareholders are included in their personal income taxes.
To put it another way: Dividends from C corporations are taxed twice - once by the corporation as part of its profits at a rate equal to your marginal tax bracket plus the additional Medicare surtax on investment income.
A C corporation is ideal for those businesses that want to attract investors or want to be traded on the stock market because the investors can receive dividends and capital gains.
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FAQs
Can a Single-Member LLC Owner Be On the Payroll?
A single-member LLC that runs a trade or business is subject to self-employment tax, just like sole proprietorships. Owners are not allowed to be on a payroll, i.e., they can't deduct wages to pay themselves.
Can an LLC Have w2 Employees?
W-2 income is not available to an active member of an LLC since he or she is not regarded as an employee of the company unless they choose to be treated as a C or S corp.
Will an LLC Save Me Money?
LLCs are not double taxed by their default pass-through status. That means that these business entities can save you a lot of money annually.
Is LLC Income Considered Earned Income?
Even though the pro-rata share of profits from an LLC member or S corporation shareholder isn't considered earned income, it is treated as a return on investment and taxed at the owner's marginal income tax rate. Only actual W-2 wages may be generated by the business, which means that the owner can only create earned income if they receive them.
Is LLC Income Active or Passive?
It depends on whether a member of an LLC is actively or passively involved in a trade or business of the LLC. If a member is actively involved in running the company, then that member's distributive share from an LLC would be considered active income and not subject to self-employment tax.
In contrast, if they were passive in their involvement with the company (i.e., just invested money), then all their distributive shares from an LLC would be treated as being passive income for federal tax purposes and therefore subject to self-employment tax on net earnings from self-employment.
Does an LLC Need a Separate Bank Account?
LLCs are not required to have a separate business bank account. However, it is best practice for LLCs to have separate bank accounts to track the business's expenses and income. LLC owners should always keep their personal finances utterly different from their business accounts and have a personal bank account.
Can an LLC Have Multiple Bank Accounts?
You can establish as many commercial bank accounts as you want, as long as you fulfill the criteria of your chosen financial institution. It is a must for a company owner to keep their business and personal finances separate. However, you may also want to split up some of your company's financial activities among several accounts.
Can an LLC Have Guaranteed Payments?
LLC s can have guaranteed payments, provided that they specified this in an operating agreement.
However, the LLC will not be able to pay itself guaranteed payments if it does not have enough money to pay all other members.
If an LLC has a member who is receiving guaranteed payments, then the member can request payment even if there are insufficient funds available for distribution. Guaranteed payments don't have any tax implications.
Can LLC Have No Employees?
Yes. An LLC can operate without employees. Simply because entrepreneurs own part of the LLC does not make them employees.
Can You Get Equity in an LLC?
Yes. You can get equity in an LLC in two ways, either by buy-in or by capital contribution. You can also get equity through profit interest units which are a great way to attract employees or investors. This implies granting a share of your business to the other person or entity, often in exchange for an investment.
Can an LLC Raise Capital?
Yes. Raising capital for an LLC implies raising money for the company through the equity route by selling ownership interests in your company.
You may either raise equity capital through gaining financial partners with cash to contribute or having investors in your company, depending on how you want to look at it.
How to Pay Yourself From an LLC: Conclusion
When it comes to paying yourself for your business, there are a lot of considerations.
You must take the time to understand how an LLC works and what taxes will be coming out at year-end.
If you need help figuring this stuff out or have any other questions about protecting your personal assets, don't hesitate to reach out for professional tax advice.
