How Do I Pay Myself From My LLC? Salary, Draws, and Tax Tips

Choosing how to pay yourself from your LLC impacts both personal and business finances. The method you select affects tax obligations, cash flow, and compliance with legal requirements. Understanding owner compensation ensures you optimize financial benefits while adhering to regulations.

Tax Election Considerations

Choosing the appropriate tax election for your LLC is a critical decision that shapes your tax liabilities and financial strategy. The IRS allows LLCs to be taxed as a sole proprietorship, partnership, S corporation, or C corporation, each with distinct implications. A single-member LLC is typically treated as a disregarded entity, meaning income is reported on the owner’s personal tax return. While this simplifies tax filing, it may not always be the most efficient option.

Electing S corporation status can help LLCs with substantial profits reduce self-employment taxes. This is achieved by splitting income between salary, which is subject to payroll taxes, and distributions, which are not. However, the IRS requires owners to pay themselves a “reasonable” salary based on industry standards and business performance.

C corporation status may suit LLCs planning to reinvest profits or attract investors. While C corporations face double taxation—once at the corporate level and again on dividends—a flat 21% corporate tax rate and potential deductions can mitigate this. Additionally, C corporations can offer stock options, a tool for recruiting and retaining talent.

Salary or Draw Options

The decision between a salary and a draw depends on the LLC’s tax classification and financial goals. LLCs taxed as sole proprietorships or partnerships generally use draws, which are not subject to payroll taxes. However, owners must leave enough funds in the business for expenses and tax liabilities. Keeping accurate records of draws is essential to avoid IRS scrutiny.

For LLCs taxed as S corporations, owner compensation combines salary and distributions. The IRS mandates a “reasonable” salary for services rendered, subject to payroll taxes, to prevent tax avoidance through disproportionately high distributions. For example, an LLC owner in consulting earning $100,000 annually could raise IRS concerns by setting a $30,000 salary.

In LLCs taxed as C corporations, salaries are deductible business expenses, reducing corporate taxable income. However, dividends paid to owners are not deductible, leading to double taxation. This structure is often suitable for businesses prioritizing growth or retaining earnings. Careful tax planning is essential to balance these factors effectively.

Tax Withholding and Reporting

Tax withholding and reporting are critical for LLCs taxed as S or C corporations. Payroll taxes, including federal income tax, Social Security, and Medicare, must be withheld from employee salaries, including owner-employees. Noncompliance can result in penalties. IRS Form 941, filed quarterly, is used to report these withholdings.

Withholding calculations depend on factors like the employee’s W-4 form and the Federal Insurance Contributions Act (FICA) tax rate, which is 15.3% for 2024, split between employer and employee. State and local tax requirements may also apply, adding complexity. Many LLCs use payroll software to automate calculations and filings, reducing errors and ensuring compliance.

For LLCs where owners take draws instead of salaries, withholding does not apply, but quarterly estimated tax payments are required to cover income and self-employment taxes. This prevents unexpected tax liabilities and ensures compliance.

Recordkeeping for Owner Compensation

Accurate recordkeeping for owner compensation is essential for financial transparency and tax compliance. Implementing accounting software to manage payroll, automate journal entries, and generate financial reports minimizes errors and streamlines processes.

Understanding Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) is important for proper classification of compensation expenses. Differentiating between wages and owner draws in financial statements ensures an accurate reflection of the company’s financial position. Maintaining documentation like employment agreements, timesheets, and distribution records creates a clear audit trail, invaluable during tax assessments or financial reviews.