How to Pay Yourself as an LLC

Owning an LLC offers flexibility in how you take income. Unlike a salary, LLC owners typically withdraw profits through “owner’s draws” or profit distributions. 

 

This article will explore the different methods for paying yourself from your LLC, considering tax implications and best practices.

 

Understanding Your LLC Structure

 

 

An LLC, or Limited Liability Company, is a business structure that combines the features of corporations and partnerships.

 

Here’s a breakdown of some key aspects of LLC structure:

 

Limited Liability Protection

 

This is a major advantage of LLCs. It shields the owners’ personal assets from liability for the company’s debts and obligations. So, if your LLC gets sued or faces bankruptcy, your personal house, car, etc., are generally protected.

 

Pass-Through Taxation

 

LLCs themselves don’t pay income tax. Profits and losses “pass through” to the members of the LLC and are reported on their personal tax returns. This prevents double taxation, where a company pays taxes on profits and shareholders are taxed on dividends received.

 

Management Structure

 

LLCs are flexible in how they are managed. There are two main options:

 

     •  Member-managed: The members themselves handle the day-to-day operations of the LLC.

     •  Manager-managed: Members appoint managers who are responsible for running the business.

 

This is typically defined in a document called an Operating Agreement, which lays out the rules for how the LLC is run, profit and loss sharing, and other important details.

 

Membership

 

LLCs can have one or multiple members, who can be individuals, other businesses, or even trusts. There are usually no restrictions on the number of members an LLC can have.

 

Interesting Read: Federal income tax – Understanding your Paystub

 

Methods for Paying Yourself as an LLC

 

LLC owners can pay themselves in various ways, depending on the type of LLC and the tax structure chosen. Here are the common methods:

 

1. Owner’s Draw (Single-Member LLCs)

 

This method offers simplicity for single-member LLCs. It’s basically like taking money out of your personal account but from the business account. There’s no set salary or formal pay structure.

 

The withdrawn amount is considered a distribution of profits and is reported on Schedule C of the owner’s personal tax return. 

 

Crucially, owner’s draws don’t incur payroll taxes, making it an attractive option for new businesses or those with fluctuating income.

 

However, since owner’s draws aren’t considered wages, they don’t directly contribute to Social Security benefits. Instead, they are subject to self-employment taxes, including Social Security and Medicare contributions.

 

Now, what of multi-member LLCs?

 

With multiple owners, things get more structured. Profits are the money left after expenses are paid. Each member receives a share of the profits based on their ownership percentage (e.g., 50/50 split for two owners). 

 

These distributions happen periodically, like monthly or quarterly, depending on your agreement.

 

2. Salary (C Corporations & S Corporations)

 

LLCs that choose to be taxed as C corporations or S corporations can pay their members a regular salary. This works similarly to how traditional employees are paid. The benefit of this approach is that the salary can be deducted as a business expense.

 

This lowers the LLC’s taxable income.

 

However, paying a salary means the LLC has to deal with payroll taxes. These include Social Security and Medicare taxes, which need to be withheld from the salary.

 

On the other hand, S corporations have an extra advantage when it comes to taxes. While the salary paid to members is subject to payroll taxes, their profit distributions are not. These profit distributions are not subject to self-employment taxes. 

 

This can lead to some tax savings.

 

A Quick Read: Who handles payroll in a company

 

3. Guaranteed Payments (Multi-Member LLCs)

 

Guaranteed payments offer stability, unlike fluctuating profits. They are fixed payments to LLC members regardless of profitability. We can consider them set salaries, not based on ownership percentages.

 

For the LLC, these payments are beneficial as they can be deducted as business expenses, reducing taxable income. However, it’s important to understand the tax implications for members.

 

Now, while guaranteed payments boost members’ income, they’re subject to self-employment taxes, unlike traditional salaries. Unlike salaries, these payments don’t qualify for payroll tax withholdings, shifting tax responsibility to the member.

 

4. Hiring Yourself as an Independent Contractor

 

This is an option for multi-member LLCs. A member can be hired as an independent contractor, requiring IRS forms (W-9 and 1099-MISC). This offers some flexibility but with less favorable tax treatment than other methods.

 

The LLC can indeed deduct payments made to independent contractors as a business expense. Additionally, the member (as the contractor) is responsible for self-employment taxes on the entire income received.

 

Considerations When Paying Yourself

 

 

When determining your pay as an LLC owner, it’s important to consider key factors to manage your business effectively and comply with tax regulations.

 

Paying Yourself Too Much

 

Paying yourself too much could affect your ability to get loans for your small business. Lenders look at how much you pay yourself to judge how financially healthy your business is. 

 

If your salary is too high compared to what your business earns, lenders might worry that your business won’t be able to pay back the loan.

 

Paying Yourself Too Little

 

On the other hand, underpaying yourself can attract attention from the IRS.

 

Let’s say you run a graphic design firm. The average salary for a graphic designer in your area is $60,000 per year. But to save money, you decide only to pay yourself $30,000.

 

The IRS examines business tax returns and compares owner salaries to industry standards. In this scenario, there’s a significant difference between your reported income ($30,000) and the fair market value of your services ($60,000).

 

This raises a red flag for the IRS, who might suspect you’re underreporting your income to pay less in taxes.

 

What will be the cost?

 

If the IRS audits your business and finds evidence of underpayment, you could face several penalties:

 

     •  Back taxes: You’ll owe taxes on the unreported income, plus interest.

     •  Underpayment penalties: The IRS may charge additional penalties for intentionally underpaying your taxes.

     •  Accuracy-related penalties: You could face even steeper penalties if the underpayment were due to negligence.

 

Example:

 

Continuing with our graphic design example, let’s assume the marginal tax rate for your income bracket is 25%.

 

Here’s a simplified breakdown of the potential costs:

 

     •  Unreported income: $60,000 (fair market value) – $30,000 (reported salary) = $30,000

     •  Back taxes: $30,000 x 25% = $7,500

     •  (Assuming) Penalty: Let’s say the penalty is 20% of the back taxes = $1,500

 

This is just a simplified example, and the actual costs could be much higher depending on the specifics of your situation.

 

Keeping Excellent Books

 

It’s super important to keep good records of all your money when paying yourself as an LLC owner. You need to track how much money is coming in, how much you’re spending, and how much you’re paying yourself. 

 

This helps you follow the tax rules properly and makes it easier to understand your business finances.

 

Using Business Funds for Business Expenses

 

Make sure you keep your personal money and your business money separate. This means using your money only for business things, not personal things. 

 

Mixing personal and business funds can confuse you, making tracking your business’s financial performance difficult.

 

Also Read: How to File Taxes Without W2 or Paystub: A Friendly Guide

 

How to Take Control of Your LLC Finances

 

Being an LLC owner means you have special opportunities to handle your money and taxes smartly. Paystub Hero is here to help you take advantage of these opportunities. 

 

Our simple pay stub service lets you keep perfect records, make tax filing easier, and choose your pay wisely.

 

Whether taking out profits or getting guaranteed payments, Paystub Hero ensures you record everything correctly and professionally. 

 

Get started today!

 

FAQs

 

Here are the commonly asked questions about paying yourself as an LLC.