You did it … you started your small business! Like many small business owners, you opted to organize as a Limited Liability Company (LLC).
An LLC combines the flexibility of a partnership with the liability protection of a corporation. That structure helps protect your personal assets from the company's debts and liabilities. Startups, single-person businesses, micro-businesses and small businesses tend to gravitate toward an LLC. Some established businesses may also choose to form as an LLC.
Formed at the state versus federal level, an LLC offers small business owners flexible management and taxation based on business needs.
Among the many and varied questions a small business owner has about operating an LLC include those related to how to pay yourself:
- Can the owner of an LLC pay himself through payroll?
- How do owners pay themselves in an LLC?
- What is the most tax efficient way to pay yourself in LLC?
- What percentage should I pay myself from my LLC?
- Can I fund my LLC with my own money?
Read on for more information to help you understand more about how to pay yourself as an LLC business owner.
Understanding LLC Payment Structures
One significant advantage of an LLC is the pass-through taxation feature, where profits are only taxed at the individual level. This helps a small business owner avoid the double taxation corporations face.
LLCs also provide operational flexibility, since there are fewer formalities compared to corporations.
What Is an LLC and How Does It Affect Owner Compensation?
An LLC provides several ways to pay yourself based on whether you form a single-member LLC or a multi-member LLC.
The IRS will treat an LLC as either a corporation, partnership, or as part of the owner’s tax return (a “disregarded entity”). 1
Single-Member LLC
- Owned by one person.
- Treated as a "disregarded entity" for tax purposes. That means the business typically reports profits and losses on the owner's personal tax return. This structure offers simplicity in tax filing but requires adherence to separate accounting for personal and business finances to maintain liability protection.
Multi-Member LLC
- Owned by two or more people and considered a partnership for tax purposes.
- Each member reports income on their tax return based on their share of the business. This structure allows for more complex ownership and profit-sharing arrangements, ideal for businesses with multiple stakeholders.
LLC Payment Options Based on Tax Classification
LLC payment options vary based on tax classification, or designation. Each designation describes how the Internal Revenue Service (IRS) will tax a company. It also outlines the rules an LLC must follow to stay compliant with the IRS.
The designations include:
- Single-member LLC, taxed as a “disregarded entity.”
- Multi-member LLC, taxed as a general partnership.
- LLC taxed as an S Corporation.
- LLC taxed as a C Corporation.
If you’d like the IRS to tax your LLC as a single-member entity, you’ll need to reflect LLC activities on the owner’s federal tax return.
You'll also need to complete and file:
- Form 1040 or 1040-C, Profit or Loss from Business (Sole Proprietorship)
- Form 1040 or 1040 SR Schedule E, Supplemental Income or Loss
- For 1040 or 1040-SR Schedule F, Profit or Loss from Farming
- It’s important to note that a single-member entity is automatically treated as a “disregarded entity.”
If you’d like the IRS to tax your LLC taxed as a multi-member entity, you’ll need to complete and file:
Keep in mind that a multi-member entity is typically taxed as a partnership by default. That means the LLC owners report their share of income or losses on their personal tax returns. Each owner may also be required to pay self-employment tax on their share of partnership earnings.
If you’d like the IRS to tax your LLC as an S Corporation, you’ll need to complete and file:
- File Form 2553, Election by a Small Business Corporation, with the IRS. If approved, the IRS will tax your LLC as an S Corp, and you’ll need to complete and file Form 1120-S, U.S. Income Tax Return for an S Corporation.
- Each owner must also file Schedule K-1 (Form 1120-S), Shareholder’s Share of Income, Deductions, Credits, etc. .
- S Corp taxation means that company profits pass through to owners’ personal tax returns.
If you’d like the IRS to tax your LLC as an C Corporation, you’ll need to complete and file:
- Form 8832, Entity Classification Election. If approved, the IRS will tax your LLC as a C Corp, and you’ll need to complete and file Form 1120, U.S. Corporation Income Tax Return.
- C Corp taxation means that the IRS will treat the LLC as a separate tax-paying entity. This option can lead to double taxation, where the LLC pays taxes on its profits and members pay taxes a second time on distributions.
Whether this is your first or 50th tax filing, it’s always a good idea to check with a trusted professional about your specific situation. You can also check out IRS Publication 3402, Tax Issues for Limited Liability Companies.
How to Pay Yourself in a Single-Member LLC
Paying yourself from an LLC requires careful consideration of your business structure and tax implications.
In general, it’s important to balance between reinvesting in your business and covering personal expenses. Here’s a few factors to consider when deciding on your compensation structure:
- Business financial health, industry standards, and personal financial needs. Balancing these factors ensures sustainable business growth and financial security.
- As your business evolves, your compensation strategy may need adjustments. Regularly evaluate your business's performance and financial goals to ensure your compensation aligns with your long-term goals.
- Reinvesting profits into your business can drive growth and enhance long-term profitability. Evaluate opportunities for reinvestment and allocate funds strategically to maximize returns.
When it comes to the question, how should I pay myself from my LLC, the answer varies if you’re structured as a single-member LLC.
Owner’s Draw Method
The owner's draw method allows you to withdraw funds from your business profits. It's straightforward: you transfer money from your business account to your personal account. This method is most common for single-member LLCs.
- How It Works. You can take money out of the business as needed, but it's crucial to ensure that these draws don't exceed your business's available profits. Keeping detailed records of these transactions is essential for accurate tax reporting.
- Tax Implications. Owner's draws are not subject to payroll taxes; however, the income is still subject to self-employment taxes. Understanding how these taxes affect your financial planning is crucial for supporting your financial health.
- Pros and Cons. The owner's draw method offers simplicity and flexibility, but it requires discipline in managing cash flow to avoid financial strain on the business.
Payroll Method
The payroll method can be used for LLCs taxed as corporations.
- How It Works. This method involves paying yourself a salary as if you were an employee of your LLC. This method requires you to withhold payroll taxes.
- Setting a Salary. Determining a reasonable salary is vital to help comply with IRS standards. Your salary should reflect what someone in your position and industry would earn, which helps prevent IRS penalties.
- Tax Withholdings. With the payroll method, you must withhold and remit payroll taxes, including Social Security, Medicare, and federal and state income taxes. This requires a structured payroll system to help ensure compliance.
- Advantages and Challenges. This method provides a consistent income stream and simplifies personal tax calculations. However, it involves more administrative work and requires careful planning to manage cash flow effectively.
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How to Pay Yourself in a Multi-Member LLC
In general, multi-member LLC owners pay themselves through guaranteed payments, owner draws, or a combination of both.
Muti-member LLC owners may also opt to pay themselves as a W-2 employee or 1099 independent contractor. They may also opt to keep the money in the business.
Payroll for Multi-Member LLCs
Should they choose, LLC members can opt to be paid “on payroll” if they meet two important caveats:
- The LLC must file for S-Corp status with the IRS, meet specific requirements, and be approved by the IRS.
- The LLC member pay must reflect the proper payroll withholding taxes.
Distributions vs. Guaranteed Payments
Choosing between distributions and guaranteed payments depends on your LLC's financial situation and strategic goals. It's essential to align these payment methods with your business objectives to optimize financial outcomes.
- Distributions are payments made to LLC members based on their ownership percentage. They are typically subject to income tax but not self-employment tax. Distributions allow for profit-sharing among members and can vary based on the company's financial performance.
- Multi-member LLCs often use Guaranteed Payments to members for services rendered or for capital invested, regardless of the company's profitability. Guaranteed payments ensure that members receive compensation even if the business is not yet profitable, providing stability and incentivizing member contributions.
Taxes and Compliance When Paying Yourself
Understanding the tax implications is crucial when deciding how to pay yourself.
Proper tax planning helps to ensure compliance and optimize your financial position. Here’s a few tips:
- Familiarize yourself with the components of self-employment taxes and how they apply to your business income. This understanding is crucial for accurate tax planning and compliance.
- Consider strategies such as estimated tax payments and retirement contributions to manage your tax liability effectively. These strategies can enhance your financial planning and reduce the impact of taxes on your cash flow.
- A tax professional can provide insights into refining your tax strategy and ensuring compliance with self-employment tax requirements. Their expertise can guide you in developing a comprehensive tax plan tailored to your business needs.
Self-Employment Taxes and How They Apply to LLC Owners
LLC owners must pay self-employment taxes, which cover Social Security and Medicar.
If you own your own business, are a sole proprietor, or work as an independent contractor you do not pay FICA tax. Instead, you will cover your Social Security and Medicare obligations through the Self-Employed Contributions Act (SECA).
The owner's draw is subject to self-employment tax, while distributions may not be, depending on your LLC's tax classification.
- Calculating Self-Employment Taxes. The current rate is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. It's essential to calculate these taxes accurately to avoid penalties and ensure you're meeting your tax obligations.
- Planning for Payments. Setting aside funds regularly to cover self-employment taxes can prevent financial strain when payments are due. Consider quarterly estimated tax payments to manage your tax liability effectively.
- Impacts on Retirement Savings. Higher self-employment taxes may reduce the amount you can save for retirement. Explore retirement savings options like a SEP IRA or Solo 401(k) to mitigate this impact and secure your financial future.
Payroll Taxes and Withholdings
If you choose the payroll method, you must withhold payroll taxes from your salary. This includes Social Security, Medicare, and federal and state income taxes.
- Implementing a Payroll System. A reliable payroll system ensures accurate tax withholdings and timely payments. Many business owners use payroll software or services to manage this process efficiently.
- Compliance Requirements. Understanding federal and state payroll tax requirements is critical for compliance. Regularly review tax rates and regulations to avoid penalties and ensure your payroll practices align with current laws.
- Benefits of Proper Withholding. Accurate tax withholdings simplify year-end tax filing and prevent unexpected tax bills. This proactive approach enhances financial predictability and stability.
Best Practices for Paying Yourself from an LLC
When it comes to paying yourself from an LLC, it’s important to keep two best practice themes top of mind: proper IRS protocol and practical payment processes.
IRS regulation demands an accurate record of all payments. Here’s a few organization tips to help you maintain records.
- Record-Keeping Practices. Keep detailed records of all financial transactions, including the owner's draws, payroll, and distributions, is essential for accurate tax reporting. Implementing accounting software can streamline this process and enhance record accuracy.
- IRS Reporting Requirements. Understand IRS requirements for reporting LLC income and payments ensures compliance and reduces the risk of audits. Regularly review IRS publications and updates to stay informed.
- Seek Professional Advice. A tax professional can offer personalized guidance tailored to your specific situation, helping you navigate complex tax regulations and improve your financial strategy.
- Keep Personal and Business Finances Separate. Always keep separate accounts for your business and personal finances to avoid complications. This separation not only protects your personal assets but also simplifies accounting and tax reporting.
- Set a Reasonable Salary. If using the payroll method, ensure your salary is reasonable and aligns with industry standards to avoid IRS scrutiny. Research industry norms and adjust your salary as your business evolves to help ensure compliance and financial sustainability.
- Regularly Review Your Payment Method. As your business grows, your payment method might need adjustments. Regular reviews can help ensure you're optimizing your tax situation. Evaluate your business's financial performance and tax strategy periodically to adapt to changing circumstances and maximize profitability.
- Set a Payroll Schedule. Whether you have one employee or several, you’ll need to maintain compliance with tax and employment laws and consistently meet payroll obligations, including how and when to issue paychecks or post EFT payment.
Another set of LLC best practices answers the question; can I fund my LLC with my own money?
Yes, you can invest personal funds into your LLC. These contributions can be recorded as capital investments, which can be withdrawn later through distributions or draws.
If you opt to fund your LLC with personal funds, keep the following in mind:
- Recording Contributions. It's crucial to document these contributions accurately to ensure clarity in financial records. This documentation supports your claims during audits and helps track your investment in the business.
- Impact on Ownership. Capital contributions may affect ownership percentages, especially in multi-member LLCs. Understanding how these contributions impact your ownership stake is vital for maintaining control and aligning interests.
- Future Withdrawals. Planning for how and when to withdraw your contributions can impact your business's cash flow and tax liability. Consider consulting a financial advisor to develop a withdrawal strategy that aligns with your financial goals.
Conclusion
Paying yourself from an LLC involves understanding your business structure, choosing the right payment method, and managing tax obligations.
Invest time in staying informed and following best practices. By doing so, you can streamline payroll processes, help ensure compliance and focus more on growing your business.
Here’s a few final tips:
- Ongoing Education. Continuously educating yourself about tax laws and financial management can empower you to make informed decisions and adapt to changing circumstances. Staying informed positions you to respond proactively to new challenges and opportunities.
- Building a Support Network. Engaging with financial advisors, tax professionals, and other business owners can provide valuable insights and support. Building a network of trusted advisors enhances your decision-making and business resilience.
- Focusing on Growth. With a solid understanding of how to pay yourself from your LLC, you can shift your focus to strategic growth and long-term success. By mastering these elements, you'll be better positioned to manage your LLC's finances effectively and enjoy the rewards of your hard work.
Remember, consulting with a tax professional can provide personalized guidance tailored to your specific situation.
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1 Single member limited liability companies | Internal Revenue Service
