How to Pay Yourself as a Business Owner LLC

LLC owners often wonder how to legitimately pay themselves while adhering to tax regulations. Compensation methods vary, largely depending on how the IRS classifies your LLC for tax purposes. Understanding these distinctions helps maintain compliance and financial health.

Paying Yourself as a Single-Member LLC

A single-member LLC (SMLLC) is considered a “disregarded entity” by the IRS. For federal income tax purposes, the business is not treated as separate from its owner. All business income and expenses are reported directly on the owner’s personal tax return, specifically on Schedule C (Form 1040).

SMLLC owners primarily receive money through an “owner’s draw” or “owner’s distribution.” This is a withdrawal of funds for personal use, not a salary. It involves transferring money from the business bank account to a personal bank account.

Owner’s draws are not subject to payroll withholding taxes because they are not salaries. However, owners are responsible for self-employment taxes, covering Social Security and Medicare contributions. These taxes are calculated on the business’s net profit, not just the amount drawn. The self-employment tax rate is 15.3% on net earnings, comprising 12.4% for Social Security and 2.9% for Medicare.

Owner’s draws are not tax-deductible for the business and do not reduce the LLC’s taxable income. Owners pay income and self-employment tax on the LLC’s entire net profit, regardless of the amount drawn. Maintaining separate business and personal finances, including distinct bank accounts, is recommended for clarity and liability protection.

Paying Yourself as a Multi-Member LLC

Multi-member LLCs are taxed as partnerships by the IRS. The LLC itself does not pay income tax; instead, profits and losses “pass through” to individual members, who report their share on personal tax returns. The LLC files Form 1065, U.S. Return of Partnership Income, and issues a Schedule K-1 (Form 1065) to each member, detailing their share of income, deductions, and credits.

Multi-member LLC owners receive money through “guaranteed payments” and “distributions.” Guaranteed payments compensate for services or capital provided, similar to a salary. These payments are deductible for the LLC and subject to self-employment tax for the recipient partner. Partners must include guaranteed payments as net earnings from self-employment.

Distributions represent allocations of the LLC’s profits and are not subject to self-employment tax. Members are liable for income tax on their share of the LLC’s net income, as reported on Schedule K-1, whether or not profits are distributed. This pass-through taxation means members pay self-employment and income tax on their allocated share of profits.

A well-drafted operating agreement benefits multi-member LLCs. It outlines how profits and losses are shared, how payments are made, and the rights and responsibilities of each member. This helps define the distinction between guaranteed payments and distributions, which have different tax implications.

Paying Yourself When Your LLC is Taxed as an S Corporation

An LLC can elect S corporation taxation by filing Form 2553 with the IRS, changing how the owner is compensated and taxed. An S corporation owner actively working in the business must pay themselves a “reasonable salary” for services performed. This salary is subject to federal income tax withholding and payroll taxes, including FICA, Social Security, and Medicare.

The IRS requires a “reasonable salary” to prevent owners from minimizing payroll taxes by taking all compensation as distributions. The salary should reflect what other businesses pay for similar services and responsibilities. This salary is reported on a Form W-2, like any employee’s wages.

Beyond the reasonable salary, remaining profits can be taken as “distributions.” These distributions are tax-free up to the owner’s basis and are not subject to self-employment taxes. This can lead to tax savings compared to an LLC taxed as a sole proprietorship or partnership, where all profits are subject to self-employment tax.

Operating an S corporation involves administrative requirements, including running payroll for the owner. This means withholding federal income and FICA taxes from the salary and remitting amounts to the IRS. The business must file quarterly payroll tax returns (Form 941) and annual federal unemployment tax returns (Form 940), plus any applicable state forms. Failure to pay a reasonable salary can lead to IRS scrutiny, reclassification of distributions as wages, and penalties.

Managing Your Tax Responsibilities

Regardless of how an LLC is taxed, owners have ongoing tax payment obligations. Many LLC owners, particularly those of single-member LLCs and multi-member LLCs taxed as partnerships, are responsible for making estimated tax payments to the IRS. This applies to income not subject to withholding, such as business profits and guaranteed payments.

Estimated tax payments cover income and self-employment tax. These payments are made quarterly to ensure tax obligations are met as income is earned. The IRS sets specific due dates:
April 15 for income earned January 1 to March 31.
June 15 for April 1 to May 31.
September 15 for June 1 to August 31.
January 15 of the following year for September 1 to December 31.

If a due date falls on a weekend or holiday, the deadline shifts to the next business day.

Taxpayers use Form 1040-ES to calculate and make these payments. The IRS encourages electronic payment methods like IRS Direct Pay, EFTPS, or their online account. Payments can also be mailed with Form 1040-ES vouchers. Estimate income accurately to avoid underpayment penalties.

Penalties for underpayment of estimated taxes apply if individuals do not pay at least 90% of their current year’s tax liability or 100% of their prior year’s (110% for higher-income taxpayers). Penalty calculation considers the amount and period of underpayment, and published quarterly interest rates. S-Corp owners may also need to make estimated payments for additional income not covered by W-2 withholding, such as investment income. Accurate record-keeping helps in calculating payments and ensuring tax compliance.