How to Pay Yourself from a Single-Member LLC

A Single-Member Limited Liability Company (SMLLC) offers business owners liability protection. A common question for these owners is how to pay themselves from the business. The method for withdrawing funds and corresponding tax implications depend on how the Internal Revenue Service (IRS) classifies the SMLLC for tax purposes. This understanding is foundational to proper financial management and tax compliance.

Understanding Your SMLLC’s Tax Classification

For federal income tax purposes, an SMLLC has two tax classifications, which directly influence how its owner is compensated. By default, the IRS treats an SMLLC as a “disregarded entity.” This means the business is not taxed separately; its income and expenses are reported directly on the owner’s personal income tax return, much like a sole proprietorship.

An alternative is for an SMLLC to elect to be taxed as an S-corporation. This election treats the business as a separate entity. To make this election, the owner must file Form 2553, “Election by a Small Business Corporation,” with the IRS. This changes how the owner receives compensation and associated tax obligations.

With S-corporation status, the business files its own tax return, and profits and losses pass through to the owner’s personal return. Understanding this initial tax classification is the first step in determining the appropriate strategy for paying yourself from your SMLLC.

Paying Yourself as a Disregarded Entity

When an SMLLC is taxed as a disregarded entity, the owner pays themselves through “owner’s draws” or “owner’s distributions.” These are not considered a tax-deductible business expense for the LLC.

There is no formal payroll process for a disregarded entity; no W-2 forms are issued, and no federal income or payroll taxes are withheld from these draws. Instead, the business’s net profit, after all deductible expenses, is subject to self-employment taxes. This tax covers Social Security and Medicare contributions, calculated at a combined rate of 15.3% on net earnings from self-employment.

Because no taxes are withheld from owner’s draws, the owner is responsible for making estimated tax payments throughout the year. These quarterly payments, due on April 15, June 15, September 15, and January 15 of the following year, cover both income tax and self-employment tax obligations. Failure to make sufficient estimated tax payments can result in penalties. Maintaining clear bookkeeping for all owner’s draws is important for accurate financial record-keeping.

Paying Yourself as an S-Corporation

When an SMLLC elects S-corporation tax status, the owner pays themselves through a “reasonable salary” and owner distributions. This salary is paid via formal payroll, with federal income tax, Social Security, and Medicare taxes withheld. The owner receives a W-2 form for this salary.

The IRS requires that the salary paid to an S-corporation owner be “reasonable,” meaning it must be comparable to what a similar professional in the same industry and geographic area would earn for similar duties. Factors such as the owner’s training, experience, duties, and responsibilities are considered when determining a reasonable salary.

After paying a reasonable salary, any remaining profits can be taken as owner distributions. These distributions are not subject to self-employment taxes or additional payroll taxes. The S-corporation is responsible for formal payroll processing, filing regular payroll tax forms like Form 941, “Employer’s Quarterly Federal Tax Return,” and Form 940, “Employer’s Annual Federal Unemployment Tax Return.”

Key Tax Obligations and Reporting

For SMLLCs taxed as disregarded entities, business income and expenses are reported on Schedule C, “Profit or Loss From Business (Sole Proprietorship),” with the owner’s Form 1040, “U.S. Individual Income Tax Return.” Schedule C’s net profit determines self-employment tax liability on Schedule SE, “Self-Employment Tax.” Owners must make quarterly estimated tax payments using Form 1040-ES, “Estimated Tax for Individuals,” to cover both income tax and self-employment tax obligations throughout the year.

SMLLCs electing S-corporation status have different reporting responsibilities. The S-corporation files Form 1120-S, “U.S. Income Tax Return for an S Corporation.” The owner, as an employee, receives a Form W-2 for their salary. The S-corporation also issues a Schedule K-1, “Shareholder’s Share of Income, Deductions, Credits, etc.,” to the owner, detailing their share of income that flows through to their personal Form 1040.

The S-corporation also has ongoing payroll tax obligations, filing forms like Form 941 quarterly and Form 940 annually. Maintaining separate bank accounts for business and personal finances is a good practice, regardless of tax classification. This separation simplifies financial tracking and streamlines tax preparation.