Navigating the nuances of paying yourself from a limited liability company (LLC) can be challenging. This guide provides a comprehensive overview of the different approaches and tax implications that LLC owners need to be aware of.
Whether you operate a single-member LLC, are part of a multi-member setup, or fall under the corporate LLC umbrella, you need the right information to make an informed decision.
How Do You Pay Yourself From an LLC?
Owning and operating an LLC involves a multitude of responsibilities, including understanding how to properly compensate yourself. As varied as LLCs can be, so are the methods of distributing funds to owners. Let’s explore.
Paying Yourself Through an Owner’s Draw
An owner’s draw serves as the most straightforward method for distributing funds to yourself. Essentially, you write a check from your business bank account to your personal bank account. In bookkeeping terms, this translates to a debit in your owner’s equity and a matching credit in the owner’s draw account.
However, there’s a tax angle you can’t overlook — the IRS requires you to pay income tax on your LLC’s profits, whether you leave them in the business or take them out as a draw. On top of this, you may need to pay self-employment taxes, covering both Social Security and Medicare, at a rate of 15.3%.
Single-Member LLCs
If you are the sole proprietor of a single-member LLC, the IRS views you as a disregarded entity. That means your business income and personal income are considered one and the same.
Multi-Member LLCs
For a multi-member LLC, the IRS classifies the business as a pass-through entity, filing its income through IRS Form 1065. Yet, the partnership itself is not subjected to income tax.
Each member pays a share of income tax based on their portion of the business profits, as delineated in the LLC operating agreement. Even if you don’t take your full share of the profits, you’ll still pay income tax on your designated share come tax time. “Being strategic with your ownership percentage as a partner can have drastic effects on how your income is taxed. Using a proactive CPA and compliance company could make a difference in your tax bill in a partnership,” notes Taylor Fike, Partner at Fike Advisors and Expert Contributor for Mosey.
Corporate LLCs
Corporate LLCs operate under an entirely different paradigm. As a member of an LLC structured as a C-corp or S-corp, you can’t take an owner’s draw. Instead, you must become an employee of your own company and take a reasonable salary.
This salary is subject to both income and payroll taxes. Any profits above and beyond this can be distributed as dividends, which have their own tax implications. Fike highlights that “The benefits of an S-Corp, C-Corp, and partnership are very minute, but have major effects on your tax strategy. Dividends have tax advantages that a good CPA can take advantage of for you and your business.”
How Much Should You Pay Yourself?
The IRS suggests that LLC owners should give themselves reasonable compensation. The term “reasonable” remains undefined, but you can take the following steps to figure out your salary:
- Calculate personal expenses: First, total your personal expenses for the year. This amount serves as the minimum you need to earn.
- Assess business finances: Next, consult your accountant and review your financial statements to determine what your business can afford to pay you beyond your personal expenses.
- Industry and job statistics: Research the average salary range for your position within your industry. This data provides a useful benchmark.
- Finalize your salary: Taking all this information into account, determine a salary amount that is justifiable to both you and any governing bodies.
The more you designate as salary, the more payroll tax you’ll be responsible for, compared to what you might earn through dividends. Balancing between the two can help you optimize your tax obligations. An accountant’s expertise could be invaluable here.
When you’re ready to pull money out of your business, remember these tips:
A paper trail is key: Ensure that any money transferred from your business to your personal account is fully documented. Financial institutions should report the amount drawn, and keeping accurate records is crucial.
Check or online transfer: Using a check or an online transfer is a safe method, as it naturally leaves a paper trail. Conversely, taking cash directly doesn’t provide a clear record.
Drawing money: It’s within your rights to draw money from the business as you see fit, as long as it’s properly documented. Failing to document could leave you vulnerable to legal issues.
The goal is to have a well-documented and justifiable approach to paying yourself to protect both your personal and business finances. Always consult professionals for personalized advice.
Does an LLC Require Self-Employment Taxes?
Taxation laws can be quite a maze for business owners. When it comes to LLCs and self-employment taxes, you may have a few questions. Let’s clarify.
Self-Employment Taxes for Single-Member LLCs
If you establish a single-member LLC and opt not to be taxed as a C-corporation, you’ll continue to be on the hook for self-employment taxes. Essentially, your tax liability for self-employment taxes remains unaltered.
In this scenario, your LLC is often considered a disregarded entity for tax purposes, much like a sole proprietorship.
How Do Self-Employment Taxes Work for an LLC?
Your LLC’s income will pass through to your personal income tax return, usually on a Schedule C. You’ll then pay self-employment taxes (Social Security and Medicare) based on that income. This differs from the payroll taxes you’d pay as an employee.
How Do Distributions Factor Into LLCs?
While you may draw distributions from the company’s profits, remember that these are not immune from self-employment taxes. Your bookkeeping should reflect this to maintain a clear financial history.
Corporate Tax Option
If you elect to have your LLC taxed as a C-corporation, different rules apply. You’d be required to pay yourself a reasonable salary and might also receive distributions. In this case, your salary is subject to payroll taxes, but the distributions could potentially offer tax savings.
Legal and Financial Implications
To make sure you are paying taxes correctly, you may need to reach out to a CPA for tailored advice. Paying self-employment taxes is not just about fulfilling legal obligations. It also provides personal liability protection, especially if your business structure includes an operating agreement that outlines these responsibilities.
How Do You Pay Income Tax From LLC Income?
When paying income tax from your LLC income, the method varies depending on the type of LLC you’re operating. Understanding these variations is critical to compliance and ensures you’re not over or underpaying.
Single-Member LLC Taxes
When you’re the only member of an LLC, you’re essentially a single-member LLC. As we mentioned, you may be considered a disregarded entity. This basically means that the IRS treats your LLC profits and losses as personal income and expenses.
You report these via Schedule C of your personal income tax return (IRS Form 1040).
Multi-Member LLC Taxes
In the sphere of multi-member LLCs, the tax game gets a bit more nuanced. As part of a pass-through entity, members of the LLC report their share of the profits on their personal income tax returns.
You’ll usually handle this via IRS Form Schedule K-1, which documents each member’s share of the company’s profits and losses. “Owner equity becomes a crucial part of the balance sheet in a multi-member LLC because it influences the capital gain for tax purposes when an owner decides to sell out their portion of company ownership,” notes Fike.
Corporate LLC Taxes
Some LLCs choose to be taxed as a C-corporation, often called a C-corp. This move changes the tax structure quite a bit. Instead of profits flowing through to personal income tax, the business itself pays corporate tax.
Business owners can then pay themselves a reasonable salary and perhaps even get some additional distributions. However, this setup could lead to double taxation — once at the corporate level and again when distributions are made.
What About Payroll Taxes?
If you’re an owner of an LLC, you need to note your payroll tax obligations regularly. You’ll also need to file a W-2 form, which provides the IRS with a detailed account of your payments and withheld taxes.
This document essentially serves as a snapshot of your income throughout the fiscal year and plays a vital role when it’s time to pay the IRS.
What Are the LLC Benefits for Owners?
Now, about those owner’s draws. As the owner of an LLC, paying yourself generally happens through an owner’s draw. This isn’t a guaranteed payment. Rather, it’s a transfer of some of the business’s cash reserves to you for personal use.
Multi-member LLCs divide these draws among the partners, usually in accordance with the LLC operating agreement. It’s essential to manage these draws responsibly, given their impact on net income and tax payments. Just remember to leave a comprehensive paper trail, especially if you want to enjoy tax benefits down the line.
The tax rate you’ll be subject to can vary, so consult a tax professional if necessary — this guide is for informational purposes, and it’s always best to seek professional advice.
Payroll Compliance With Mosey
LLC owners make hundreds of decisions a day to keep their businesses running. Paying yourself from an LLC is just one of them. That’s why it’s important to have a partner that helps you steer clear of payroll pitfalls. Here’s where we come in.
Mosey’s platform guides you through your payroll compliance needs, ensuring that you meet all your legal obligations by automating the process to open payroll accounts and which state and local laws you need to pay attention to.
If you’re ready to take the guesswork out of payroll and tax compliance, give Mosey a try and see how we can make your life easier, one payroll period at a time.
