As a business owner, you may find it more advantageous to form a limited liability company or LLC rather than operate as a sole proprietorship or general partnership. The main reason for this is that if the business fails, creditors can go after only the LLC's assets and not those of its individual owners. This is called "limited liability."
On the other hand, LLCs are just like traditional corporations in that it's possible for an owner to take cash out of the company.
Reasons You May Want To Make A Withdrawal
Limited liability companies are formed to protect their owners from being personally liable for the LLC's debts and liabilities.
However, this benefit doesn't extend to all of an LLC's activities. If you're found guilty of some kind of intentional misconduct, then your limited liability might not apply.
In some cases, one of the benefits of operating as a limited liability company is that it's possible to take cash out of the company.
There are all kinds of reasons why you might want to make a withdrawal, including:
To Reduce the Risk of Losing Your Money
Taking money out of the company reduces the amount that's available for potential lawsuits.
Let's say you're personally liable for a substantial debt, but there isn't enough cash in the LLC to cover it. Rather than shutting down or filing bankruptcy, you can take money out of the LLC to meet your payment obligations.
To Save Money on Taxes
If you're operating your business as a sole proprietorship or general partnership, then you'll have to pay taxes on all profits that are left in the company.
However, if you withdraw money from the LLC, only the amount of profit that's actually taken out is subject to taxation.
To avoid borrowing from banks: Banks will usually require at least some personal guarantees from you before they'll give a business loan. If this is the case, then withdrawing money from your LLC might be preferable to significant debt.
In a limited liability company, compensation for services rendered to the business is not counted as income.
However, if you receive a salary from your LLC and paid Social Security taxes on it, then you can deduct those amounts from your personal income tax return.
If you take money out of the company to make a withdrawal, this doesn't mean that all of these benefits will apply to you.
Before making any kind of withdrawal, it's best to consult with an experienced business law attorney who can explain how your state's laws might affect your rights and responsibilities.
How To Take Cash Out Of an LLC?
Aan LLC must prepare a written operating agreement that establishes how cash can be withdrawn from the company.
The specific details will vary depending on the circumstances involved, but there are three main types of LLCs: those that require:
- Unanimous consent from all owners (or unanimous approval from managers) to take cash out of the company
- Those that require only a majority vote from all members to withdraw money
- Those where it's possible for one or more members to make this decision without getting approval from other owners/members.
There are two ways to take cash out of your LLC: (1) you can make a "distribution," or (2) you can obtain a loan.
Distributions are not subject to self-employment tax, but they are subject to federal income taxes. Loans are treated as taxable income by default, but there is an alternative available where the lender purchases an LLC membership interest before allocating the loan proceeds among the company's members.
With distributions, you have to wait at least 13 months before withdrawing funds that were originally invested in your LLC by another member or an outside investor.
Obtaining a Loan
When compared to making a distribution, obtaining a loan is not as advantageous because lenders typically charge high-interest LLC. You should consult your accountant or submit your rates. Obtaining a loan can also be a better option than making a distribution if you need other tax benefits from the LLC.
In some cases, it might be wise to have another member become a creditor of the company so that they can take out a loan on your behalf. The creditor can then use an Operating Agreement or buyout agreement to negotiate repayment terms for this loan by buying a membership interest in the company.
Types of Business Entities and Their Withdrawal Requirements
Limited liability companies are just one form of business entity. Others include corporations, limited partnerships, and limited liability partnerships.
Cashing Out as a Single-Member LLC
If you own an LLC on your own (called a single-member LLC), then you'll need to follow the same withdrawal requirements as any other type of business entity.
A sole proprietor may withdraw funds from his firm in the same manner that a corporation does by transferring them to his personal bank account or writing himself a check out of the business bank account.
This activity is referred to as an "owner's draw," and it should be recorded in the books as such. An owner's draw is not a deductible business expense, but it can be useful in determining their income tax.
Cashing Out as a Multi-Member LLC
If you own an LLC with other people (called multi-member LLC), then there are some differences in how much cash you may be able to withdraw depending on whether your business is managed by all of the owners (called member-managed) or if it's managed by one person (called manager-managed).
If your LLC is member-managed, then all owners can participate in decisions regarding withdrawals.
This means that all members may be able to withdraw money for personal use which is also then deducted from their personal income tax.
Alternatively, if an LLC is manager-managed, then only managers are permitted to make decisions about the company's money.
Bankruptcy: If your business goes bankrupt, then you might also be able to withdraw funds for personal use without incurring too much risk.
The reason is that all of a company's assets are sold off during bankruptcy proceedings. This means that if you take out money before the bankruptcy, then you won't lose it to creditors during the process.
Cashing Out as a C Corporation
C corporations are subject to complex tax requirements. For example, if a C corporation is publicly traded on the stock market, then it may be able to pay dividends directly from its profits without incurring taxation. Dividends are distributed as cash after paying the business expenses and income taxes.
However, even if your company is private and not publicly traded, you might still be able to pay yourself via cash withdrawals.
Because this business entity is a completely separate legal entity, withdrawing money for personal use is one of the most common uses of these types of companies.
However, if you're considering making a withdrawal from your company, then you should definitely consult with an experienced business law attorney to make sure you understand all the applicable federal and state laws before proceeding.
Cashing Out as an S Corporation
S corporations are often used in small businesses. They provide many of the benefits of a C corporation without one major drawback: double taxation if your business makes a profit and you withdraw it to make a withdrawal.
However, there is good news for S corporations and their owners: withdrawals don't trigger double taxation under any circumstances.
This means that if you're an owner of an S corporation, then you don't have to worry about incurring double taxation simply because you withdraw money from your company.
Other Ways To Consider
Although most LLCs begin with one or more members, it's possible to convert them into single-member LLCs. This is often done in order to shield yourself from personal liability. However, if you go this route, then you'll want to consider keeping your business alive since you won't have anyone else to manage the company.
Salary and Bonus
You can earn a bonus if you are a member engaged in running or managing the LLC. You may be paid more as profits rise. You may take a bigger salary or give yourself a large performance bonus if your LLC's profits rise.
The IRS may look at W-2s that vary considerably from year to year, especially if they fluctuate in value and fall and then rise. Bonuses are rarely given as a result of earnings. If your LLC has more members, they must approve your compensation and keep track of the authorization to avoid any appearance of impropriety and protect the company.
The LLC can give the business owner advantages such as medical insurance, life insurance, and a cellphone as an owner. The LLC may establish a retirement plan in which you participate. This can be a significant source of cash for you if you choose the right retirement plan. In addition to this, perks like extended holiday leave, company vehicles, and specific travel and eating.
Contact the IRS to find out whether there are any rules regulating how these perks and benefits are taxed. Unless a written policy on compensation and benefits already exists, other members must consent to these bonuses and advantages if your LLC has many participants.
What Are Intermingling Funds?
Intermingling funds occurs when your business expenses become mixed with individual members' money. This can be done without intent, but it may result in the loss of the liability shield.
How Is a Loan Different from a Distribution?
Distributions are generally taken out as cash and don't have any tax consequences. Loans, on the other hand, are repaid with interest.
What Is the Entry for Owner’s Withdrawals?
The entry for the owner's withdrawals is a journal record of a withdrawal from the LLC. This can be done by a member or an outsider who has invested in the LLC.
When you decide to withdraw money from your LLC, it's important to make sure that everything is done correctly.
For instance, you'll need to follow the terms of your Operating Agreement or buyout agreement when withdrawing funds.
If you have any questions about these issues, then you should consult with an attorney immediately.