How to Take Money Out of an LLC Without Paying Taxes

Taking money out of a Limited Liability Company (LLC) has tax implications depending on how the business is structured. LLCs offer flexibility in profit distribution, but improper withdrawals can lead to unexpected tax liabilities. Business owners must understand the legal methods for accessing funds to optimize their financial strategy.

There are several ways to withdraw money from an LLC while minimizing or avoiding taxes. Each approach depends on the LLC’s tax classification and ownership structure, which determine how distributions, loans, and elections affect taxation.

Tax Classification of an LLC

The IRS taxes an LLC based on its ownership structure. By default, a single-member LLC is a disregarded entity, meaning its income and expenses are reported on the owner’s personal tax return using Schedule C of Form 1040. The LLC itself does not pay federal income tax, but the owner is responsible for self-employment taxes on net earnings. If the LLC elects S corporation status, the owner can take a salary and receive distributions, potentially reducing self-employment tax liability.

A multi-member LLC is classified as a partnership by default, requiring the business to file Form 1065 and issue Schedule K-1s to each member. Profits and losses pass through to individual tax returns, avoiding double taxation. However, members must pay self-employment taxes on their share of earnings unless the LLC elects S corporation status, which changes how income is reported and taxed.

An LLC can also opt for C corporation taxation by filing Form 8832. This subjects the business to a corporate tax rate of 21%. While this allows profits to be retained without immediate taxation to owners, withdrawing money as dividends results in double taxation—once at the corporate level and again at the individual level. Some business owners use this structure to reinvest profits while minimizing personal tax liability.

Single-Member LLC Distributions

A single-member LLC owner can withdraw funds freely, as these withdrawals are not considered taxable events. Since the LLC is a disregarded entity, the owner is taxed on all net earnings regardless of whether the money is taken out or left in the business. Withdrawals are typically recorded as owner draws, which transfer funds from the business account to the owner’s personal account. These draws are not subject to payroll taxes but do not reduce self-employment tax liability.

Unlike corporations, a single-member LLC does not separate income into salary and dividends, meaning all earnings are subject to self-employment taxes. Some owners attempt to classify withdrawals as business expense reimbursements, but these must be properly documented. If an expense lacks proper records, the IRS may reclassify it as taxable income.

Multi-Member Profit Allocation

For multi-member LLCs, profit distribution is governed by the operating agreement. By default, profits and losses are allocated based on ownership percentages, but special allocations are allowed if they meet IRS requirements under Section 704(b). These allocations must reflect real economic consequences for the members involved; otherwise, the IRS may reclassify them, leading to additional tax liabilities.

Members are taxed on their share of the LLC’s profits whether or not they receive cash distributions. If an LLC reinvests earnings rather than distributing them, members may face tax obligations without receiving cash to cover them. To address this, many LLCs establish a tax distribution policy, ensuring members receive enough to cover their tax liabilities. A common approach is to distribute a percentage of profits equal to the highest individual tax rate among members.

Owner Loans to the LLC

Owners can inject personal funds into an LLC through a loan rather than a capital contribution. A loan creates a debtor-creditor relationship, allowing the owner to withdraw funds later without affecting ownership percentages. To ensure the IRS recognizes the transaction as legitimate, proper documentation is required, including a promissory note specifying repayment terms, interest rates, and a clear schedule for repayment.

The IRS mandates that loans meet the Applicable Federal Rate (AFR) to prevent reclassification as a below-market loan, which could result in imputed interest income for the lender under IRC Section 7872. If the LLC does not pay a reasonable interest rate, the IRS may treat the foregone interest as taxable income to the lending member. Additionally, failure to adhere to repayment terms could lead to the loan being recharacterized as a capital contribution, affecting profit allocations and member basis calculations.

S Corporation Election

Electing S corporation status can provide tax advantages by allowing business owners to split income between a salary and distributions. In a default LLC structure, all net earnings are subject to self-employment taxes. In an S corporation, only the salary portion is subject to Social Security and Medicare taxes, while distributions are taxed as ordinary income without additional payroll taxes.

To qualify for S corporation status, an LLC must meet IRS requirements, including having no more than 100 shareholders, issuing only one class of stock, and limiting ownership to U.S. individuals, certain trusts, and estates. The election is made by filing Form 2553 with the IRS. Once approved, the LLC must maintain payroll records and file Form 1120-S annually.

The IRS scrutinizes owner salaries to prevent underpayment of payroll taxes. If an owner takes an unreasonably low salary to maximize distributions, the IRS may reclassify some distributions as wages, triggering back taxes and penalties. Business owners should ensure that salaries align with industry standards to avoid IRS challenges.