How Should I Pay Myself From My LLC? A Detailed Overview

An individual forming a Limited Liability Company (LLC) often faces a fundamental question: how do I, as the owner, take money out of the business for personal use? The answer is not uniform, as the method for compensating yourself from an LLC depends entirely on how the Internal Revenue Service (IRS) classifies your business for tax purposes. Understanding these classifications is the first step in establishing a compliant and financially sound approach to paying yourself.

Understanding Your LLC’s Tax Classification

The IRS does not recognize an LLC as a distinct tax classification. Instead, an LLC is taxed based on the number of members and any elections made by the owner or owners. A single-member LLC (SMLLC) is taxed by default as a disregarded entity, meaning its income and expenses are reported on the owner’s personal tax return, similar to a sole proprietorship.

For LLCs with multiple members, the default tax classification is a partnership. This means the LLC itself does not pay federal income tax; instead, profits and losses are passed through to the individual members, who then report their share on their personal tax returns. Each member receives a Schedule K-1 detailing their share of the LLC’s income, deductions, credits, and other items.

An LLC can also elect to be taxed as a corporation, either an S-corporation or a C-corporation. To elect S-corporation status, an LLC must file Form 2553, Election by a Small Business Corporation, with the IRS. This election can offer potential tax benefits, particularly concerning self-employment taxes on distributions. An LLC can also elect to be taxed as a C-corporation by filing Form 8832, Entity Classification Election.

Paying Yourself from a Pass-Through LLC

When an LLC is taxed as a sole proprietorship (for SMLLCs) or a partnership (for multi-member LLCs), owners compensate themselves through an owner’s draw. An owner’s draw involves directly transferring funds from the business bank account to a personal account. This is not considered a salary or wage, and the LLC does not withhold income taxes or FICA taxes (Social Security and Medicare) at the time the draw is taken.

The owner’s share of the LLC’s net profits, not the draw itself, is what is subject to income tax and self-employment tax at the individual level. For 2024, self-employment tax is 15.3% on net earnings from self-employment, consisting of 12.4% for Social Security up to an annual earnings limit ($168,600 for 2024) and 2.9% for Medicare with no earnings limit. This tax is calculated on 92.35% of the net earnings from self-employment.

For multi-member LLCs taxed as partnerships, members may also receive “guaranteed payments.” These are specific payments made to a partner for services rendered or for the use of capital, regardless of the partnership’s income. Guaranteed payments are distinct from owner’s draws because they are treated as ordinary income to the partner and are subject to self-employment tax. They are reported on Schedule K-1 and are deductible by the partnership as a business expense.

Paying Yourself from an S-Corporation Elected LLC

An LLC that has elected S-corporation status has specific requirements for how owners who actively work in the business must be paid. The IRS mandates that such owners receive a “reasonable salary” for the services they perform for the business. This salary is paid through a formal payroll process, just like any other employee, with federal income tax, state income tax (if applicable), Social Security, and Medicare taxes withheld from each paycheck.

Determining a “reasonable salary” involves considering factors such as the owner’s duties, responsibilities, time dedicated to the business, and compensation paid by similar businesses for comparable services. This salary is reported on a Form W-2, Wage and Tax Statement. The reasonable salary requirement ensures that FICA taxes are paid on at least a portion of the owner’s compensation, preventing owners from taking all profits as distributions to avoid these taxes.

After paying a reasonable salary, any remaining profits can be distributed to the owner or owners as owner distributions. An advantage of the S-corporation election is that these distributions are not subject to self-employment tax. They are instead taxed only as ordinary income at the individual level, provided the owner has sufficient basis in the S-corporation. Distributions must be proportional to each owner’s ownership percentage to maintain S-corporation compliance.

Essential Tax Obligations and Record Keeping

LLC owners are required to pay estimated taxes quarterly throughout the year, as income and self-employment taxes are not withheld from owner’s draws or distributions (except for S-corporation W-2 salaries). Payments are made to the IRS using Form 1040-ES, Estimated Tax for Individuals, and to relevant state tax authorities. The quarterly due dates are April 15, June 15, September 15, and January 15 of the following year.

Maintaining a clear separation between personal and business finances is also important for any LLC owner. This involves establishing separate business bank accounts and credit cards distinct from personal accounts. Such separation helps preserve the limited liability protection offered by the LLC structure, as commingling funds can potentially allow creditors to pierce the corporate veil. It also simplifies accurate accounting and tax preparation, making it easier to track business income and expenses.

Accurate record-keeping is a continuous requirement for all LLC owners. This includes maintaining detailed records of all income, business expenses, owner’s draws, salaries, and distributions. Documents include bank statements, receipts for all business expenditures, payroll records for S-corporation owners, and any corporate minutes or resolutions related to distributions. Records are important for demonstrating compliance with tax laws, preparing accurate tax returns, and successfully navigating any potential audits by tax authorities.