How to Put Yourself on Payroll With an LLC

A Limited Liability Company, or LLC, is a business structure that offers owners liability protection, separating personal assets from business debts. Understanding how LLC owners receive compensation is important. While “putting yourself on payroll” is a common phrase, the actual method depends on the LLC’s tax structure. This article guides readers through compensation methods and the processes for formal payroll.

Understanding LLC Owner Compensation Structures

The IRS classifies LLCs in several ways for tax purposes, directly influencing owner compensation. An LLC’s default tax classification significantly impacts whether an owner can, or should, be on formal payroll.

A single-member LLC is typically a “disregarded entity,” treated as a sole proprietorship for federal tax purposes. The owner is not an employee and does not receive a W-2 wage. Instead, the owner takes “owner draws” or “distributions” from profits, which are not subject to income tax withholding or payroll taxes. The LLC’s net income is reported on Schedule C (Form 1040), and the owner pays self-employment taxes (Social Security and Medicare) on this profit.

A multi-member LLC is typically taxed as a partnership. Owners, referred to as partners, receive their share of profits as “distributive shares” or “guaranteed payments.” Like single-member LLCs, partners do not receive a W-2 wage or formal payroll. Each partner’s income share is reported on Schedule K-1 (Form 1065), and they pay self-employment taxes on their portion.

An LLC owner can be formally placed on payroll when the LLC elects S-corporation tax status. This election changes the IRS’s view of the entity and owners, while maintaining liability protection. An S-corporation owner who actively works for the business is considered an employee and must receive a “reasonable salary.” This salary is subject to federal income tax withholding, Social Security, and Medicare taxes (FICA), like other employee wages.

Remaining profits can be distributed to the owner as tax-free distributions, provided the owner has sufficient company basis. This dual compensation structure—a W-2 salary and tax-free distributions—often motivates S-corporation election. While an LLC can elect C-corporation status, S-corporation election is more common for small business owners seeking specific payroll and distribution benefits, making it the focus for detailed payroll discussions.

Steps Before Running Payroll for S-Corporation Owners

Before processing payroll, an S-corporation owner must complete several preparatory steps to ensure compliance with federal and state regulations. These steps establish the legal and administrative framework for formal employment.

Employers, including S-corporations paying owners a salary, must obtain an Employer Identification Number (EIN) from the IRS. This nine-digit number serves as a federal tax ID for the business, similar to a Social Security number. The EIN identifies the business to the IRS and other government agencies for employment tax purposes.

Businesses must register with relevant state and, in some cases, local agencies. This typically includes registering with the state’s unemployment insurance agency to pay SUI taxes, and with the state revenue department for state income tax withholding if applicable. Registration processes vary significantly by state; guidance is available on state labor and revenue agency websites. Some localities may also have payroll tax requirements.

Choosing an appropriate payroll system is important. Options range from dedicated software for calculating withholdings and generating forms, to full-service providers handling all payroll aspects. Manual processing is also an option, though it carries a higher risk of error and can be time-consuming. Select a system aligning with the business’s complexity and the owner’s comfort level.

S-corporation owners must determine a “reasonable salary” for their services. The IRS mandates this salary reflect the fair market value of their work, considering industry, qualifications, duties, and time devoted to the business. The IRS may scrutinize low salaries, as this could attempt to reclassify salary as tax-free distributions, avoiding FICA taxes. Businesses should document their reasonable compensation figure, referencing industry benchmarks or professional studies.

Before the first payroll run, the S-corporation owner, as an employee, must complete standard employment documentation. This includes providing personal details for payroll, completing a Form W-4 to specify federal income tax withholding, and submitting a Form I-9 to confirm legal work eligibility. These forms are fundamental for accurate tax withholding and employment law compliance.

Processing and Reporting Payroll for S-Corporation Owners

After preparatory steps, an S-corporation owner can proceed with running payroll and fulfilling ongoing compliance. This involves calculating wages, withholding taxes, and remitting them to authorities on schedule. Adhering to these procedures ensures compliance with federal and state payroll tax laws.

Processing payroll involves calculating the owner’s gross pay and determining withholdings. Federal income tax withholding is based on the owner’s Form W-4. FICA taxes (Social Security and Medicare) must be withheld from gross wages. Social Security tax is 6.2% on wages up to an annual limit; Medicare tax is 1.45% on all wages, with an additional 0.9% surtax on high earners. State income tax withholding must also be calculated and withheld if applicable, based on state-specific tables and forms.

After calculating and withholding taxes, funds must be remitted to tax agencies. Federal payroll taxes, including withheld income tax and both employee and employer FICA portions, are typically deposited using the Electronic Federal Tax Payment System (EFTPS). Deposit frequency (semi-weekly or monthly) depends on the business’s total tax liability from a prior lookback period, as determined by IRS rules. State payroll taxes, including unemployment insurance and income tax withheld, are deposited according to state-specific methods and schedules.

S-corporations must file various payroll tax forms periodically. Form 941, the Employer’s Quarterly Federal Tax Return, reports wages, tips, federal income tax withheld, and both employee and employer shares of Social Security and Medicare taxes for the quarter. This form is due by the last day of the month following each calendar quarter. Annually, businesses must file Form 940, the Employer’s Annual Federal Unemployment Tax Return, reporting FUTA tax.

Businesses must also file state-specific unemployment and withholding forms. These forms vary by state and may be due quarterly, annually, or on other schedules. Many states require quarterly wage reports for unemployment insurance.

At year-end, the S-corporation must prepare a Form W-2, Wage and Tax Statement, for the owner, reflecting gross wages, federal income tax, and FICA taxes withheld. A copy must be provided to the owner by January 31st of the following year, and another filed with the Social Security Administration by the same deadline.

Maintaining accurate payroll records is essential for ongoing compliance. Records should include gross wages, tax withholdings, net pay, and proof of tax deposits and form filings. Meticulous record-keeping is necessary for reconciling accounts, responding to tax authority inquiries, and facilitating audits. Records should be kept for at least four years from the tax due or payment date, whichever is later, as required by the IRS.