How to Pay Yourself in a Multi-Member LLC

Multi-member Limited Liability Companies (LLCs) offer a flexible structure for business ownership. This flexibility extends to how owners, known as members, receive payments. Understanding these compensation methods is important for operational efficiency and tax compliance. This article explains the different ways members of a multi-member LLC can pay themselves.

Methods for Member Compensation

Members of a multi-member LLC can receive payments through several distinct methods. These methods reflect their contributions and the company’s financial performance. Distinguishing between these methods based on their fundamental nature, separate from their tax treatment, is important.

One common method is through Guaranteed Payments. These are fixed amounts paid to a member for services rendered or for the use of capital, regardless of the LLC’s profitability. These payments are consistent and predictable. They differ from a traditional salary because the recipient is still considered a partner for tax purposes, not an employee.

Another primary method is through Distributive Shares, also known as owner’s draws or distributions. These represent a member’s share of the LLC’s profits, allocated according to the ownership percentages or profit-sharing ratios defined in the operating agreement. Unlike guaranteed payments, distributive shares depend on the LLC generating a profit. Members typically take these funds out of the business as needed.

Beyond these primary methods, members can also receive Expense Reimbursements. These are not compensation or income, but a repayment to a member for legitimate business expenses they paid personally on behalf of the LLC. For instance, if a member uses personal funds to purchase office supplies or cover travel costs, the LLC can reimburse them.

Tax Treatment of Member Payments

How a multi-member LLC member receives payment directly impacts their personal tax liability and the LLC’s tax reporting. Each payment method is treated differently under federal tax law, influencing self-employment and ordinary income taxes. Understanding these distinctions is crucial for accurate tax planning and compliance.

Guaranteed Payments are treated as ordinary income to the recipient for income tax purposes. These payments are also subject to self-employment (SE) taxes, which include Social Security and Medicare taxes. The member is responsible for paying both the employer and employee portions of these taxes. The LLC treats guaranteed payments as a deductible business expense, reducing the LLC’s overall taxable income that is passed through to the members.

Regarding Distributive Shares, an active member’s share of the LLC’s ordinary business income is subject to self-employment tax and ordinary income tax. This applies even if the member does not take a physical distribution of the profits. The “pass-through” nature of an LLC means the business itself does not pay federal income tax. Instead, the LLC’s income, gains, losses, and deductions flow through to the members’ personal tax returns. Members report their share of the LLC’s income on Schedule K-1, which then flows to their personal Form 1040.

Expense Reimbursements are generally not considered taxable income to the member, provided they are made under an “accountable plan.” For a reimbursement plan to be accountable, expenses must have a business connection. Members must adequately substantiate their expenses to the LLC within a reasonable time. Any excess reimbursements must be returned to the LLC. If these conditions are not met, the reimbursements may be treated as taxable income to the member.

An important consideration for tax treatment is the Impact of LLC Tax Elections, particularly if the LLC elects to be taxed as an S-Corporation. This election significantly alters how members are compensated and taxed. When an LLC elects S-Corp status, members who provide services to the LLC must be paid a “reasonable salary” for their services. This salary is subject to payroll taxes (Social Security and Medicare) and reported on Form W-2. Any additional profits distributed to members beyond this reasonable salary are generally considered non-taxable distributions up to the member’s tax basis in the LLC, and are not subject to self-employment tax. This election changes the default tax treatment from a partnership model to a corporate model for tax purposes, while retaining the liability protections of an LLC.

Operational and Reporting Requirements

Multi-member LLCs must adhere to specific operational and reporting requirements. These steps ensure member compensation is properly documented, accounted for, and reported to tax authorities. This adherence is important for maintaining compliance.

The Operating Agreement is the foundational document for a multi-member LLC. It outlines how members will be compensated. This agreement should clearly define how profits and losses are allocated among members, the procedures for making distributions, and any provisions for guaranteed payments. A well-drafted operating agreement provides a roadmap for financial operations and helps prevent disputes among members.

Proper Recording Payments (Bookkeeping) is essential for transparency and tax compliance. All payments made to members, whether guaranteed payments, distributions, or expense reimbursements, must be accurately recorded in the LLC’s accounting records. Guaranteed payments are typically recorded as an expense, while distributions are debited against the owner’s equity accounts. Maintaining separate bank accounts for the LLC and its members is an important practice to ensure clear financial separation and easier tracking.

Making the Actual Payments is a straightforward procedural step. Once amounts and methods are determined and recorded, funds are transferred from the LLC’s bank account to the members. This can be done through direct bank transfers, checks, or electronic payment systems. The chosen method should provide a clear transaction record for bookkeeping purposes.

For federal tax reporting, multi-member LLCs are typically treated as partnerships and must file Form 1065, U.S. Return of Partnership Income, annually. This form reports the LLC’s overall income, deductions, and other financial information. As part of filing Form 1065, the LLC must issue a Schedule K-1 (Partner’s Share of Income, Deductions, Credits, etc.) to each member. The Schedule K-1 details each member’s share of the LLC’s income, deductions, credits, and any guaranteed payments received. Members then use this information to prepare their personal income tax returns (Form 1040).