How Do You Pay Yourself From an LLC?

A Limited Liability Company (LLC) is a flexible business structure that provides its owners, known as members, with personal liability protection, shielding their personal assets from business debts. How an LLC owner draws money for personal use largely depends on how the Internal Revenue Service (IRS) classifies the entity for tax purposes.

Paying Yourself from an LLC Taxed as a Sole Proprietorship or Partnership

An LLC defaults to a pass-through taxation structure. A single-member LLC (SMLLC) is taxed as a sole proprietorship, while a multi-member LLC is taxed as a partnership. Owners take “owner’s draws” or “distributions” from profits instead of a traditional salary. These draws are not considered wages, and the LLC does not withhold income or payroll taxes.

The LLC’s net income, or profit, “passes through” directly to the owner’s personal tax return. For an SMLLC, this profit is reported on Schedule C. For a multi-member LLC, each owner’s share of profit or loss is reported on Schedule K-1, and then flows to their personal Form 1040.

Owners are responsible for self-employment taxes on their share of the LLC’s net earnings. These taxes cover Social Security and Medicare. Since no taxes are withheld from owner’s draws, owners must pay estimated quarterly taxes using Form 1040-ES to cover their income and self-employment tax obligations.

To manage owner’s draws effectively, maintain clear financial records. Owners should use separate business bank accounts and track all transfers to personal accounts. Draws are recorded as a reduction in the owner’s equity, representing funds taken from their ownership stake or accumulated profits.

Paying Yourself from an LLC Taxed as an S Corporation

An LLC can elect to be taxed as an S corporation by filing Form 2553 with the IRS. This changes how owners are compensated and taxed. Owners who actively work for the LLC must pay themselves a “reasonable salary” for their services.

A reasonable salary is what a similar professional would earn for comparable services. This salary is subject to regular payroll taxes, including Social Security, Medicare (FICA), and federal income tax withholding. The LLC must run payroll, issue a Form W-2 to the owner-employee, and comply with payroll tax filings like Form 941 and Form 940.

After paying a reasonable salary, any remaining profits can be taken as “distributions.” These distributions are not subject to self-employment taxes, offering tax savings compared to other LLC tax structures. Distributions are considered a return on investment and are tax-free up to the owner’s basis in the LLC. They are reported on Schedule K-1.

The distinction between salary and distributions is an important part of the S corporation tax structure. The IRS scrutinizes the reasonableness of the salary to prevent owners from taking excessive distributions to avoid self-employment taxes. Accurate payroll records and adherence to federal and state payroll tax requirements are necessary to maintain compliance. The administrative burden for an S corporation is higher due to payroll processing and more complex tax filings.

Paying Yourself from an LLC Taxed as a C Corporation

Less common for small businesses, an LLC can elect to be taxed as a C corporation by filing Form 8832. Under this structure, the LLC is treated as a separate legal entity for tax purposes. Owner-employees are paid a salary, which is subject to standard payroll taxes and income tax withholding, similar to an S corporation.

The C corporation must pay its own corporate income tax on its profits using Form 1120. The owner’s salary is a deductible business expense for the corporation, reducing its taxable income. After corporate taxes are paid, any remaining profits can be distributed to shareholders, including owner-employees, as dividends.

Dividends are subject to “double taxation”: the corporation pays tax on its profits, and then shareholders pay tax again on the dividends received on their personal tax returns. These dividends are reported to shareholders on Form 1099-DIV. This double taxation is a disadvantage of the C corporation structure for business owners.

Factors Guiding Your Payment Method Choice

The decision of how to pay yourself from an LLC is tied to its tax classification, which carries implications for tax burden, administrative complexity, and business goals. Each structure presents a different total tax liability for the owner and the business. For instance, pass-through entities like sole proprietorships and partnerships avoid corporate-level taxation, but owners pay self-employment tax on all profits.

The administrative complexity and associated costs vary across classifications. An SMLLC or multi-member LLC taxed as a partnership has simpler bookkeeping and tax filing requirements, such as Schedule C or K-1. Conversely, S corporations and C corporations incur additional costs for payroll processing, more extensive tax filings like Forms 1120-S or 1120, and compliance with payroll tax regulations.

The level of profitability can influence the best tax structure, particularly regarding the potential for self-employment tax savings with an S corporation election. For high-profit businesses, the S corporation can offer tax advantages by allowing distributions to bypass self-employment tax. The number of owners guides the initial classification, with single-member entities defaulting to sole proprietorships and multi-member entities to partnerships.

A business’s growth and investment needs also influence the choice. C corporations, for example, might be more attractive for businesses looking to retain earnings for reinvestment or to attract external investors due to their corporate structure and ability to issue various classes of stock. Given the complexity of these financial and tax considerations, consulting with a tax professional or accountant is advisable to determine the best payment method and tax classification for your business.