How Do You Pay Yourself as an LLC Owner?

Limited Liability Companies (LLCs) offer flexibility, particularly in choosing how the entity is taxed. This choice directly influences how an owner can pay themselves, impacting personal tax obligations and the business’s financial structure. Understanding these tax classifications is important for determining the most suitable compensation strategy.

LLC Tax Classifications

The Internal Revenue Service (IRS) assigns a default tax classification to an LLC based on its number of owners, known as members. A single-member LLC is typically treated as a “disregarded entity,” meaning it is taxed as a sole proprietorship by default. Its income and expenses are reported directly on the owner’s personal tax return, on Schedule C (Form 1040). For multi-member LLCs, the default tax classification is a partnership. In this arrangement, profits and losses flow through to each member’s personal tax return, with the LLC filing an informational return (Form 1065) and issuing Schedule K-1s to its members.

Beyond these default classifications, an LLC can elect to be taxed as either an S-corporation or a C-corporation. To elect S-corporation status, an LLC files Form 2553 with the IRS. This election can provide tax advantages, particularly concerning self-employment taxes. Alternatively, an LLC can elect to be taxed as a C-corporation by filing Form 8832. The chosen tax classification dictates the rules for owner compensation and associated tax responsibilities.

Owner Compensation for Pass-Through LLCs

For LLCs taxed as sole proprietorships or partnerships, owner compensation involves direct access to business profits. Owners of single-member LLCs, taxed as sole proprietorships, typically take “owner’s draws.” This is money taken from the business for personal use and is not a deductible business expense for the LLC.

The owner’s share of the LLC’s profits, including any draws, is reported on their personal tax return. For a sole proprietorship, this profit is reported on Schedule C (Form 1040) and is subject to both ordinary income tax and self-employment tax. Self-employment tax covers Social Security and Medicare contributions, calculated at a rate of 15.3% on net earnings from self-employment.

For multi-member LLCs taxed as partnerships, owners can receive “guaranteed payments.” These are payments made to a partner for services rendered or capital provided to the partnership, regardless of the partnership’s income. Guaranteed payments are deductible business expenses for the LLC, reducing the company’s net profit. They are reported on Form 1065 by the LLC and on Schedule K-1 by the individual partner. Similar to owner’s draws, guaranteed payments are subject to self-employment tax and ordinary income tax on the owner’s personal return. Both owner’s draws and guaranteed payments emphasize the importance of careful record-keeping and cash flow management.

Owner Compensation for LLCs Taxed as S-Corporations

When an LLC elects to be taxed as an S-corporation, the owner compensation structure changes. Owners who actively work in the business are required by the IRS to pay themselves a “reasonable salary” as W-2 wages. A reasonable salary is defined as the amount a similar person would be paid for similar services in a similar industry. The IRS scrutinizes these salaries to ensure they are not artificially lowered to avoid payroll taxes.

This salary is subject to federal income tax withholding, as well as Social Security and Medicare taxes (FICA). FICA taxes are split between the employer (the S-corporation) and the employee (the owner), with each paying 7.65% of the salary. After paying a reasonable salary, any remaining profits can be distributed to the owners as owner distributions.

These distributions are generally not subject to self-employment tax or FICA taxes, making them a tax-efficient way to extract profits from the business. This dual compensation method—a W-2 salary subject to payroll taxes and distributions free from self-employment taxes—is a primary reason many LLCs elect S-corporation status.

Owner Compensation for LLCs Taxed as C-Corporations

For LLCs that elect to be taxed as C-corporations, owner compensation aligns with traditional corporations. Owners who perform services for the C-corporation are considered employees and must be paid a salary through payroll. This salary is subject to federal income tax withholding, Social Security, and Medicare taxes (FICA).

The C-corporation can deduct the owner’s salary as a business expense, which reduces the corporation’s taxable income. After salaries and other business expenses, the C-corporation pays corporate income tax on its net profits, currently at a flat federal rate of 21%. Any remaining profits can then be distributed to shareholders (owners) as dividends.

Dividends are not deductible business expenses for the C-corporation. When shareholders receive these dividends, they are taxed again at the individual level, a concept known as “double taxation.” This means the same income is taxed once at the corporate level and again at the individual shareholder level, distinguishing C-corporations from pass-through entities.