How you pay yourself from your Limited Liability Company depends on whether you are the sole member or part of several members.
An LLC is taxed as a sole proprietorship if it has one member or whether it’s a partnership. However, you could also elect your LLC to be treated as a C corporation or an S corporation.
Default rule taxing does not treat members as employees; therefore, they cannot receive a salary. However, if you decide your LLC is to be taxed as a corporation, the members who are actively working for the LLC will be treated as employees and are paid a salary (find out more in our 'Single Member vs. Multi-Member LLC' post).
What is LLC?
Limited Liability Company LLC features both characteristics of a corporation and a partnership or a sole proprietorship. LLC owners are referred to as LLC members and include individuals, corporations, and other LLCs. They are easy to create and allow for more tax flexibility.
LLC members can list their profits and losses as a corporation, or each member can list the profit and loss generated on their personal tax returns. LLC has rules that vary depending on statutory requirements and the amount of liability protection associated with LLCs.
Compared to Sole Proprietorships, the main difference is that a Sole Proprietorship can only have one owner and does not provide liability protection.
What Are The Different Types of LLCs?
There are several types of LLCs, with each classification having its own rules and tax implications. Single-Member LLC or a Sole Proprietor LLC is the most popular type.
A Single-Member LLC is different from a Sole Proprietorship. You can operate a sole proprietorship without a corporation, which puts your assets at the risk of being liable if your sole proprietorship is issued. It has a sole owner responsible for all company transactions, taxes, and business debts. It is the cheapest and easiest to form.
However, an LLC can have multiple members and can exist as General Partnership, Family Limited Partnership, or Member-Managed LLCs.
Multi-Member LLC business structures allow all the members to take responsibility for taxes and debts, although one member can retain total liability in some cases.
General Partnerships are preferred mainly by medium-sized and small business entities. It's essentially an LLC business agreement between two people.
Also, to be able to recognize the most appealing aspects of forming an LLC that best suit your needs, you may want to turn to a LLC formation service - see the best ones here - or ask some of the registered agents for a legal advice. Conveniently, we've already dedicated thorough reviews to some of the top such services out there like Nolo (see article), Rocket Lawyer (read more), Zen Business (see review), or Incfile (follow link).
How Do I Pay for my LLC?
LLCs can be multi-member LLC, a partnership, or a corporate business structure. Tax options vary depending on how they're funded. A single-member LLC business entity will be taxed similarly as a sole proprietorship. Multi-member owners will have to pay their owners as part of their LLC. How to pay tax also depends on whether you operate solely or in partnership.
What is The Best Way to Pay Yourself as a Business Owner?
Two ways to pay yourself a reasonable compensation in an LLC to your personal account as the business owner is through profits and as an employee. It is important to note that it is essential to make it clear during the initial stages taken to form an LLC if you choose to be paid via profits. If the LLC is established, then there is an option for you to be an independent contractor or employee, depending on your tax situation. An LLC's owner can choose to pay himself by either owner draw or salary.
An owner's draw refers to when an owner takes funds from the LLC for personal use, commonly in small businesses.
The owner could withdraw LLC's profits or take out funds that they previously contributed to the company. They may also take out both profits and capital they previously contributed.
In a sole proprietorship, all income earned shows up on the owner's personal tax return. The owner will need to pay estimated tax payments and self-employment taxes on those earnings.
The owner doesn't pay separate taxes when they take a draw because they're simply taking out money that has been taxed in the past or money that will be taxed in the current year.
The owner's draw provides greater flexibility. The owner is not bound to a fixed payment; the compensation can change depending on the business performance. However, the draw reduces the business equity, which may limit available funds for future business spending. Every time an LLC member receives a draw, their capital account decreases by the disbursed amount.
Salary is when the business member compensates themselves with a set amount every pay period. You determine reasonable compensation and get a paycheck every pay period.
Salary reduces the admin work. The taxes are deducted from your paycheck automatically. Additionally, your compensation as the owner is a more stable expense, making it easier to track your income and LLC expenses. Salary compensation can have its challenges. When you have a downtrend in your business cash flow, adjusting your salary to meet the business condition is possible. Still, the salary should be a reasonable compensation as defined by the IRS. Again it can be challenging to figure out how much to compensate yourself.
Choosing Not to Receive Payments
You can also opt not to take a salary and leave the profits in the LLC. However, you'll still need to file individual tax on the profits earned from your LLC. The profits generated from your LLC pass through to your personal income tax return.
How to Pay Yourself From a Single-member LLC
Single-member LLC is a 'disregarded entity' Your profits and your incomes are the same. At the end of the year, the business owner reports them with Schedule C of their personal tax return. Making an owner's draw is like noting that some of your LLC's income is staying in the company as retained earnings and some of it you're taking for personal use. At the end of the tax return ( IRS Form 1040), you report it with Schedule C of your income taxes return or Schedule B of Schedule C.
How to Pay Yourself in a Multi-member LLC
Multi-member LLC owners can decide how profits will be shared and distributed between the members of an LLC. A member of the LLC can choose a pay structure depending on how they pay for their business.
How to Pay Yourself as an S Corp
An LLC taxed as an S corp has its members as employees. The members must therefore pay themselves
a reasonable salary
at least $10,000 in distributions (for the S corp to make sense financially)
An LLC classified as S corp does not pay self-employment taxes on its distribution(s). You, as the owner, will only pay income taxes on distributions. However, you'll have to pay income tax and FICA self-employed taxes on your salaries.
How S Corp Taxation Works
Each shareholder has a 25% ownership interest, meaning your share is $125,000. When you file taxes, you will each report your salary from your W-2 on your tax returns. The company must file its tax return that reports business income, profits, and losses. You will only pay income tax on the distributions of your share, which may not include your share. Your portion of FICA taxes will automatically be taken out of your salary. Your company must file FUTA tax on your worker's salaries.
How to Pay Yourself as a C Corp
Like the S corp, LLC C corp owners must get paid a "reasonable salary" for their services to the business.
Business owners pay both FICA and income taxes on their salary, but any dividends are only subject to income taxes. Unlike S corps, the C corp itself must also recompense a corporate tax on the total profits.
How C Corp Taxation Works
The C corp must file its own tax return that reports business income and profits. The company must also pay their portion of FICA taxes as well as FUTA taxes on employee salaries. Since you are the only shareholder, your dividends will be shown on Form 1099-DIV. You will then report these dividends on your individual tax return and pay income tax on them.
The company has to pay the 21% corporate tax on its profits. Your portion of the FICA tax will automatically be taken out of your salary. You are the only person who has a 25% ownership interest that means you pay yourself $125,000.
How do I Pay Taxes on My Owner's draw?
Self-employment tax is similar to FICA taxes paid for Social Security and Medicare. When you take an owner's draw of $10,000, you don't need to pay income tax on the same income you already paid last year. Almost all businesses make quarterly tax payments.
What is a Pass-through Taxation Scheme for a Partnership?
Multi-member LLCs treated as pass-through entities avoid "double taxation." LLC members choose to pay themselves a distribution or draw, then pass through to the owner's individual earnings tax return. This means the IRS doesn't tax your company's profits and then taxes your distribution from the business again.
Most small business owners choose to be taxed as a "default LLC" because there aren't enough profits carried over from year to year to justify electing S corp or C corp tax status. You must keep enough funds (or capital) in your business bank account to maintain your LLCs corporate veil. There are several factors to be considered when choosing the tax election for your LLC, making the process challenging. It's therefore essential to consult a professional CPA for tax advice.
Get a Guide on your Self Employment Taxes and other Taxes
Taxes are complicated, and business taxes, payroll taxes, and personal taxes can get mixed up.
Work with an accountant to keep your income and your taxes in order. The professional will keep you aware of all tax deductions, tax rates, and benefits available.