Can an LLC Owner Pay Himself Payroll?

Limited Liability Companies (LLCs) offer business owners a flexible structure. A common question for LLC owners is how they can compensate themselves. Understanding these compensation methods is important for managing personal finances and ensuring tax compliance. The approach depends significantly on the LLC’s tax classification.

The Default: Owner’s Draws and Pass-Through Taxation

Most LLCs begin with a default tax classification. A single-member LLC is treated as a “disregarded entity” by the IRS, and a multi-member LLC defaults to being taxed as a partnership. In both scenarios, the LLC does not pay federal income tax on its profits. Instead, the business’s income and losses “pass through” directly to the owner’s personal tax return.

For owners of these default LLCs, compensation is handled through owner’s draws. An owner’s draw is a withdrawal of funds from the business for personal use. These draws are not considered wages or salary, and are not subject to traditional payroll taxes. Taking a draw reduces the owner’s capital account but is not a deductible business expense for the LLC.

The LLC’s net profit is allocated to the owner for tax purposes. This profit is reported on the owner’s personal income tax return, typically on Schedule C (Form 1040) for single-member LLCs or via a Schedule K-1 (Form 1065) for multi-member LLCs. The LLC does not issue a W-2 form to the owner, nor does it withhold federal income tax or contributions for Social Security and Medicare. Owners are responsible for remitting these taxes through estimated tax payments.

Electing S Corporation Status for Owner Payroll

An LLC can elect to be taxed as an S corporation by filing Form 2553. This election can be beneficial for owners seeking to pay themselves a formal salary and potentially reduce certain tax liabilities. Once elected, the LLC is treated as a corporation for federal tax purposes, but its income, losses, deductions, and credits still pass through to the owners’ personal tax returns, avoiding corporate-level income tax.

A key reason an LLC owner elects S corporation status is to enable W-2 salary payment. As an S corporation shareholder-employee, the owner receives a reasonable salary for services performed, which is subject to payroll taxes. This arrangement allows for a portion of the business’s profits to be paid as salary, while any remaining profits can be distributed as non-wage distributions.

The IRS requires S corporation owner-employees to pay themselves a “reasonable salary” for the services they provide. This compensation should be comparable to what other businesses pay for similar services in the same industry. Factors considered in determining a reasonable salary include:
The owner’s training and experience.
The duties and responsibilities performed.
The time and effort devoted to the business.
The compensation paid to non-shareholder employees.
Failing to pay a reasonable salary could lead to IRS reclassification of distributions as wages, resulting in back taxes and penalties.

After a reasonable salary is paid, any additional profits can be distributed to the owner as shareholder distributions. These distributions are generally not subject to FICA (Federal Insurance Contributions Act) taxes, making them a potentially tax-efficient way to extract profits. This structure allows owners to optimize their overall tax payments by balancing salary and distributions.

Tax Implications of Owner Compensation

The method an LLC owner chooses for compensation directly impacts their tax obligations. For owners of default LLCs receiving owner’s draws, the entire net profit of the business is subject to self-employment tax. For 2025, the self-employment tax rate is 15.3%, comprising 12.4% for Social Security and 2.9% for Medicare. The Social Security portion applies to earnings up to a wage base limit, which is $176,100 for 2025, while the Medicare portion has no wage base limit. As a self-employed individual, the owner is responsible for both the employee and employer portions of these taxes.

In contrast, an S corporation owner who takes a W-2 salary is subject to FICA taxes, which are split between the employee and the employer. For 2025, the employee and employer each pay 6.2% for Social Security and 1.45% for Medicare, totaling 7.65% from each party. The Social Security portion also applies up to the $176,100 wage base limit for 2025, while the Medicare portion has no limit. This means the owner effectively pays half of the FICA taxes as an employee, and the S corporation pays the other half as the employer.

A notable difference lies in how these taxes are applied. Self-employed individuals calculate their self-employment tax on 92.35% of their net earnings from self-employment. They are also permitted to deduct one-half of their self-employment taxes paid when calculating their adjusted gross income for federal income tax purposes. S corporation owners, on the other hand, pay FICA taxes on their W-2 salary, and the S corporation can deduct the employer’s share of FICA taxes as a business expense. Additionally, for higher earners, an extra 0.9% Medicare tax may apply to wages or net earnings from self-employment exceeding certain thresholds ($200,000 for single filers, $250,000 for married filing jointly).

Other Owner Distributions

Beyond the primary compensation methods, LLCs can distribute additional profits to owners. For default LLCs, any distribution of profits to the owner is considered part of the owner’s taxable income for the year. Since these profits have already passed through to the owner’s personal tax return and been subject to income and self-employment taxes, subsequent draws of these taxed profits are generally not subject to further income tax at the time of withdrawal. These distributions reduce the owner’s capital account.

For S corporations, once a reasonable salary has been paid to the owner, any remaining profits distributed are typically considered non-wage distributions or dividends. These distributions are generally not subject to FICA (Federal Insurance Contributions Act) taxes. This structure allows for a portion of the business’s earnings to be distributed to owners without incurring additional payroll tax liabilities, distinguishing them from the W-2 salary portion that is subject to FICA. These distributions reduce the owner’s basis in their S corporation stock.