How to Properly Pay Myself From My LLC

A Limited Liability Company (LLC) offers a flexible business structure, providing owners with personal liability protection. A common question for LLC owners involves understanding the appropriate methods to draw funds for personal use. The best approach for paying oneself from an LLC is not universal; it depends on factors specific to the business, including its tax classification. This guide will clarify the various ways an LLC owner can legitimately receive payments, ensuring compliance with tax regulations.

LLC Tax Classifications and Their Implications

The Internal Revenue Service (IRS) allows an LLC to be taxed in several ways, which significantly influences how owners can receive payments. By default, a single-member LLC is treated as a “disregarded entity,” meaning it is taxed as a sole proprietorship. The business’s income and expenses are reported directly on the owner’s personal tax return, typically on Schedule C (Form 1040).

A multi-member LLC, by default, is classified as a partnership. In this structure, the LLC itself does not pay income tax; instead, profits and losses are passed through to the individual members. They report their share on their personal tax returns, often using Schedule K-1 (Form 1065).

An LLC can also elect to be taxed as a corporation by filing Form 8832 with the IRS. This means the LLC is treated as a C corporation, taxed as a separate entity, and its profits are subject to corporate income tax.

Alternatively, an LLC can elect to be taxed as an S corporation by filing Form 2553. This status maintains the pass-through taxation benefits, where income is taxed only at the owner’s individual level, avoiding corporate-level taxation.

Common Payment Methods for LLC Owners

The method an LLC owner uses to receive payment is directly tied to the LLC’s tax classification. For LLCs taxed as a disregarded entity (sole proprietorship) or a partnership, owners typically take an “owner’s draw.” This involves transferring funds from the LLC’s business bank account to the owner’s personal account, and it is recorded in the owner’s equity account. An owner’s draw is not considered a deductible business expense for the LLC.

Partners in multi-member LLCs taxed as partnerships may also receive “guaranteed payments.” These are regular payments made to partners for services rendered or capital provided, regardless of the partnership’s income. Guaranteed payments are treated as a business expense for the LLC, which reduces the business’s net profit.

For LLCs that elect to be taxed as an S corporation or a C corporation, owner-employees must pay themselves a “reasonable salary.” This salary is compensation for the work performed for the business, similar to what a comparable business would pay an employee for similar duties. The salary is processed through payroll, and it is a deductible business expense for the corporation.

After paying a reasonable salary, S corporation owners can also receive “distributions” of the company’s profits. These distributions are based on the owner’s percentage of ownership and are not considered wages. Similarly, C corporation owners can receive “dividends” from the corporate profits after a salary has been paid. Dividends are payments of corporate earnings to shareholders.

Tax Responsibilities for Owner Payments

The tax implications of owner payments vary significantly based on the LLC’s tax classification. For single-member LLCs taxed as disregarded entities and multi-member LLCs taxed as partnerships, owners are generally subject to self-employment tax. This tax covers Social Security and Medicare contributions, totaling 15.3% on net earnings from self-employment, with 12.4% for Social Security up to an annual wage base and 2.9% for Medicare on all self-employment income. Owners of these pass-through entities report their share of business income on their personal tax returns, such as Schedule C for sole proprietorships or Schedule K-1 for partnerships.

When an LLC elects to be taxed as an S corporation or a C corporation, and owners receive a salary, that salary is subject to payroll taxes. These include federal income tax withholding, Social Security, and Medicare taxes (FICA). The corporation is responsible for withholding these taxes and remitting them to the IRS, along with its share of FICA and federal unemployment taxes (FUTA).

Income tax applies to all forms of owner payments, whether they are draws, guaranteed payments, salaries, distributions, or dividends. For pass-through entities (disregarded entities, partnerships, S-corps), the business income “passes through” to the owners’ personal tax returns and is taxed at their individual income tax rates. This means owners pay income tax on their share of the LLC’s profits, even if the money is retained in the business.

C corporations, however, are subject to “double taxation.” The corporation first pays corporate income tax on its profits. Then, when these profits are distributed to owners as dividends, those dividends are taxed again at the individual shareholder level. While salaries paid by C corporations are deductible business expenses and reduce corporate taxable income, dividends are not.

Maintaining Compliance and Financial Records

Maintaining a clear separation between personal and business finances is paramount for any LLC owner. This practice helps to preserve the limited liability protection offered by the LLC structure, preventing courts from “piercing the corporate veil” and holding owners personally responsible for business debts. Establishing separate business bank accounts and credit cards is a foundational step, ensuring all business transactions are distinct from personal expenditures. This separation streamlines accounting, provides a clearer picture of the business’s financial health, and simplifies tax preparation.

Accurate and consistent record-keeping for all owner payments is also necessary. For draws and guaranteed payments, detailed ledger entries tracking the amounts and dates of transfers to owner’s equity accounts are sufficient. If an LLC pays salaries, comprehensive payroll records, including pay stubs, tax withholding statements, and payroll tax filings (e.g., Form W-2 for employees), are required. For distributions and dividends, documentation such as meeting minutes authorizing the payments and records of amounts distributed to each owner are important.

The LLC’s operating agreement is a foundational document that should clearly outline the rules for how and when owners receive payments. This agreement provides a framework for financial management and helps prevent disputes among members in multi-member LLCs. It establishes the initial capital contributions, profit and loss allocations, and distribution policies.

Navigating the complexities of LLC owner payments and their tax implications often benefits from professional guidance. Consulting with a qualified tax professional or accountant can ensure compliance with federal, state, and local tax laws. These professionals can provide tailored advice, help determine the most tax-efficient payment strategies for a specific LLC, and assist with accurate record-keeping and tax filings.