Do I Have to Pay Myself From My LLC?

A Limited Liability Company (LLC) offers a flexible business structure, appealing to many entrepreneurs. Owners often wonder how to receive funds from their LLC. Unlike traditional employees, LLC owners do not receive a standard W-2 salary automatically. The method depends on the LLC’s tax classification and the owner’s financial management.

Understanding LLC Tax Classifications

An LLC separates personal and business liabilities for its owners. For tax purposes, the IRS does not recognize an LLC as a distinct classification. Instead, an LLC is taxed based on owner elections or by default through existing business structures.

A single-member LLC (SMLLC) is, by default, a “disregarded entity” by the IRS. Its income and expenses are reported on the owner’s personal tax return, Schedule C (Form 1040). The LLC does not file a separate federal income tax return.

A multi-member LLC (MMLLC) is taxed as a partnership by default. The LLC files Form 1065, U.S. Return of Partnership Income. Each owner receives a Schedule K-1 (Form 1065), detailing their share of the partnership’s income or loss, reported on their individual Form 1040.

LLCs can elect to be taxed as an S Corporation or a C Corporation. S Corporation status is elected by filing Form 2553 with the IRS. C Corporation status requires filing Form 8832. An S Corporation LLC avoids corporate income tax by passing profits and losses directly to owners. A C Corporation LLC pays corporate income tax on profits, and shareholders are taxed again on dividends.

Owner Compensation Methods

Owner compensation methods depend on the LLC’s tax classification. These methods determine how funds are treated for accounting and tax.

Single-member LLCs taxed as sole proprietorships use an “owner’s draw.” This involves transferring funds from the business to the owner’s personal account. An owner’s draw is not a salary or wage, and is not subject to income tax withholding or payroll taxes upon withdrawal.

Multi-member LLCs taxed as partnerships use guaranteed payments and distributions. Guaranteed payments are fixed amounts paid to partners for services or capital use, regardless of partnership income. These payments are reported on Schedule K-1 and are subject to self-employment tax. Distributions represent a partner’s share of profits and are not subject to self-employment taxes.

S Corporation LLCs have a compensation requirement for active owners. Active owners must receive a “reasonable salary” for their work. This salary is subject to federal income tax withholding and payroll taxes, and the owner receives a W-2. After a reasonable salary, additional profits can be taken as distributions, which are not subject to payroll taxes.

C Corporation LLC owners who work for the company are paid a traditional “salary,” like any other employee. This salary is subject to income tax withholding and FICA taxes, and the owner receives a W-2. After corporate income taxes, remaining profits can be distributed as “dividends.”

Key Tax Considerations for Owner Compensation

Understanding the tax implications of each compensation method is important for LLC owners. Different methods carry distinct tax responsibilities.

For owners of single-member LLCs and multi-member LLCs taxed as partnerships, an owner’s draw or guaranteed payment is subject to self-employment tax. This tax covers Social Security and Medicare contributions. The current self-employment tax rate is 15.3% on net earnings up to the annual Social Security wage base, which is $168,600 for 2024. This 15.3% includes 12.4% for Social Security and 2.9% for Medicare. For earnings above the Social Security wage base, only the 2.9% Medicare tax applies.

Salaries paid to owners of LLCs taxed as S Corporations or C Corporations are subject to standard payroll taxes. These include federal income tax withholding and FICA taxes, which are split between the employer and employee. The employer’s share of FICA is 7.65% (6.2% for Social Security and 1.45% for Medicare), matching the employee’s share.

The IRS requires S Corporation owners who actively work in the business to pay themselves a “reasonable salary” before taking distributions. This rule prevents owners from minimizing payroll taxes by classifying too much of their compensation as tax-advantaged distributions. The definition of “reasonable” depends on factors like industry, experience, and duties performed. If the IRS determines a salary is not reasonable, it can reclassify distributions as wages, subjecting them to payroll taxes and potential penalties.

Distributions from pass-through entities, such as SMLLCs, partnerships, and S-Corps, are not subject to self-employment or payroll taxes. The underlying profit that generates these distributions has already been taxed at the owner’s individual income tax rate. This means the owner reports their share of the business’s profit on their personal tax return, regardless of whether they took a distribution.

C Corporations face “double taxation.” The corporation first pays income tax on its profits at the corporate tax rate, which is currently a flat 21% under federal law. When the remaining profits are distributed to owners as dividends, those dividends are taxed again at the individual shareholder level as dividend income.

Maintaining Financial Records and Compliance

Maintaining accurate financial records is important for any LLC, especially when it comes to owner compensation, to preserve the entity’s limited liability protection and ensure tax compliance. It is important to keep separate business and personal bank accounts. This separation reinforces the legal distinction between the owner and the business, which is fundamental to the limited liability shield.

Accurate record-keeping is necessary for all financial transactions, including any funds transferred to owners. This includes detailed records of owner draws, guaranteed payments, salaries, and distributions. Examples of important records are payroll registers, bank statements, general ledgers, and any formal resolutions authorizing distributions. These records provide a clear audit trail for tax purposes and financial reporting.

Tax forms vary depending on the LLC’s tax classification and compensation methods. A single-member LLC reports income and owner’s draw on Schedule C of Form 1040. Multi-member LLCs taxed as partnerships issue Schedule K-1s to partners, detailing income and distributions for personal tax returns. S Corporation or C Corporation LLCs paying salaries must issue Form W-2 and file payroll tax forms like Form 941.

Owners of pass-through entities (SMLLCs, partnerships, S-Corps) are responsible for paying estimated quarterly income and self-employment taxes. Since no tax is withheld from draws or distributions, owners must proactively calculate and pay these taxes using Form 1040-ES to avoid underpayment penalties.

Given the complexities of tax law and varying individual circumstances, seeking professional advice is recommended. Consulting with a qualified accountant, tax advisor, or legal professional provides personalized guidance. These professionals help navigate tax rules, ensure compliance, and assist in structuring owner compensation efficiently.