How to Pay Yourself from an LLC or a Sole Proprietorship

Business owners often take money from their companies for personal use, a process distinct from employee wages. The method for paying oneself varies significantly based on the business’s legal structure, impacting the owner’s income, tax obligations, and compliance with federal regulations.

Paying Yourself as a Sole Proprietor or Single-Member LLC

For tax purposes, a sole proprietorship and a single-member Limited Liability Company (LLC) that has not elected to be taxed as a corporation are treated similarly by the Internal Revenue Service (IRS). Both are considered “disregarded entities,” meaning the business’s income and expenses are reported directly on the owner’s personal tax return. The owner of such a business pays themselves through an “owner’s draw” or “owner’s distribution,” transferring funds from the business bank account to a personal account.

An owner’s draw is not considered a salary, so no payroll taxes are withheld. Instead, the business’s net income, after expenses, is reported on Schedule C of IRS Form 1040. This net income is subject to both ordinary income tax and self-employment tax. For 2024, the self-employment tax rate is 15.3% of your net earnings from self-employment. The Social Security portion applies to earnings up to $168,600 for 2024, while the Medicare portion has no wage base limit.

Since taxes are not withheld from an owner’s draw, sole proprietors and single-member LLC owners are responsible for making estimated tax payments throughout the year. These payments cover projected income tax and self-employment taxes. The IRS requires estimated tax payments if you expect to owe at least $1,000 in tax for the year. Payments are made quarterly using Form 1040-ES, with due dates usually in April, June, September, and January of the following year.

Maintaining separate bank accounts for business and personal finances is important, even though the IRS treats the entity as disregarded for tax purposes. This practice simplifies tracking income and expenses for tax reporting on Schedule C. While there are no formal payroll procedures for an owner’s draw, clear financial records help demonstrate business activity and support tax deductions.

Paying Yourself from a Multi-Member LLC

A multi-member LLC is taxed as a partnership, meaning the business itself does not pay income tax. Instead, profits and losses “pass through” to the individual members, who report their share on their personal tax returns. Members can receive payments in two primary ways: guaranteed payments and distributions. Understanding the distinction between these payment types is important due to their different tax treatments.

Guaranteed payments are regular payments made to a partner or member for services rendered to the LLC or for the use of their capital, regardless of the LLC’s profitability. These payments are treated as ordinary income to the partner and are subject to self-employment tax. The partner is responsible for both the employee and employer portions of Social Security and Medicare taxes, totaling 15.3% on their guaranteed payments, up to the Social Security wage base limit. These payments are reported to the partner on Schedule K-1 (Form 1065).

Distributions represent a share of the LLC’s profits distributed to its members. These payments are not subject to self-employment tax because the underlying income has already been passed through to the partners on their Schedule K-1. Partners pay income tax on their share of the LLC’s net earnings, which includes both guaranteed payments and their share of the remaining profits, even if those profits are not fully distributed. The terms for making distributions are outlined in the LLC’s operating agreement.

Each partner receives a Schedule K-1 from the LLC, detailing their share of the LLC’s income, deductions, credits, and distributions for the tax year. Partners use this information to complete their individual income tax returns (Form 1040). Partners must make estimated tax payments to cover their tax liabilities from LLC earnings.

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 election changes how owner-members are compensated and taxed, offering potential tax advantages. When an LLC is taxed as an S Corporation, owner-members are paid through a combination of a “reasonable salary” and “distributions.”

The IRS requires owner-employees of an S Corporation to pay themselves a “reasonable salary” for services performed for the business. A “reasonable” salary is the amount ordinarily paid for similar services by comparable businesses under similar circumstances. Factors include the owner’s training, experience, duties, responsibilities, and time devoted to the business.

This reasonable salary is treated as employee wages and is subject to payroll taxes. Both the S Corporation (as employer) and the owner (as employee) contribute to Social Security and Medicare taxes. For 2024, the employee’s share is 6.2% for Social Security (up to the $168,600 wage base limit) and 1.45% for Medicare, with the employer matching these amounts. The S Corporation is also responsible for federal unemployment tax (FUTA) on the first $7,000 of each employee’s wages.

The S Corporation must run regular payroll, withhold federal income tax, Social Security, and Medicare taxes from the owner’s salary, and remit these funds to the IRS. This involves filing quarterly payroll tax forms, such as Form 941, and annually issuing a Form W-2 to the owner-employee. This administrative burden is higher than for a sole proprietorship or partnership, requiring adherence to payroll regulations.

Any remaining profits after paying the reasonable salary can be taken as “distributions” to the owner-members. These distributions are not subject to self-employment taxes (Social Security and Medicare taxes) at the owner level. This contrasts with sole proprietorships and partnerships, where all net business income is subject to self-employment tax. Owners must ensure their salary is reasonable to avoid IRS reclassification of distributions as wages, which could lead to back taxes, interest, and penalties.