How to Pay Yourself From An LLC

How does an LLC owner get paid?

If you are in the process of structuring your business in the form of a limited liability company (LLC) or have done so already, a crucial question you might be asking is, “how do LLC owners get paid?” The answer to this question can vary.

How LLC owners get paid depends on whether the owner is the sole member (referred to as the “member”) or if there are multiple members in the LLC.

The IRS has specific guidelines regarding how LLC owners get paid and how these earnings are documented or categorized on a tax return (referred to as a tax election). The IRS requires that LLC owners must pay themselves wages as a W2 employee. That means that you must run payroll for yourself using one of the payroll services such as ADP. If an LLC only has one member, it is automatically taxed as a sole proprietorship. If it has more than one member, it is taxed as a partnership. However, there is also an option to choose to have an LLC regarded as a C corporation or S Corporation.

If an LLC is taxed in line with the default rules, the owners may not be classified as employees and are not eligible for a salary. That said, if an owner opts to have the LLC taxed in the manner of a corporation, the members who participate actively in the LLC’s operations may be regarded as employees and can be given a salary. This is one way in which LLC owners get paid.

In this article, our Los Angeles LLC attorney discusses how LLC owners get paid according to the default classifications, taking into account whether the company is a single or multi-member entity. We will also go over the implications if the limited liability company chooses to deviate from the default assignment.

How LLC owners get paid in a single-member LLC

If you are the only owner of the LLC, it is classified as a single-member entity and is typically taxed as a sole proprietorship (unless you choose to be regarded as a corporation).

That said, unlike a sole proprietorship where your business earnings are considered your salary, in a single-member LLC, you receive compensation directly via what is referred to as an “owner’s draw” from the earnings generated by your company. This entails withdrawing funds from your company for personal usage.

This can be accomplished by either writing a business check to yourself or, if your bank permits, transferring funds to your personal account from your business bank account.

Tax Obligations for a Single-Member LLC

It is crucial to understand that regardless of the amount you “draw” for your salary, your company is still subject to taxation on all its annual profits.

If you opt not to choose the status of corporation, the IRS views the LLC as a “disregarded entity.” This implies that the company is not distinct from the owner, and you would report all the losses or profits of your LLC on Schedule C.

How do payroll taxes factor in?

Since you are a single-member limited liability company, you are not classified as an employee of the company. Essentially, you are considered the company. Therefore, Medicare and Social Security contributions are not withheld. Rather, acting in the manner of a sole proprietor, you are responsible for reporting and paying self-employment taxes.

If you decide to have your company taxed in the manner of a corporation, then you may be regarded as an employee. You can take a salary that is considered “reasonable”, and Social Security, income taxes, Medicare, and other withholdings will be applied.

How LLC owners get paid in a multi-member LLC

If you are one of multiple owners in a multi-member limited liability company, you will be treated similarly to an owner in a general partnership, unless you choose to be regarded as a corporation for tax reasons.

Every member maintains a capital account. To receive payment, members of the LLC draw from their individual capital accounts, usually through a business check. Additionally, there is an option for LLC owners to get paid “guaranteed payments” or non-salary payments — essentially, a payment that is made irrespective of whether the limited liability company has created any net income in that particular quarter or month. This helps ensure a steady cash flow for each member, even during less profitable periods.

It is imperative for your LLC to have an operating agreement, whether or not it is a single- or multi-member company. Within this document, you can specify how LLC owners get paid. You may also establish guidelines for when LLC owners get paid, determine if a vote is required, and address other pertinent matters. Additionally, all members should come to a consensus on how the company’s profits will be divided — whether according to percentage of ownership, or by some other criteria. If you fail to address these matters in the operating agreement, the default rules of the LLC statute under which your company was established will address these issues.

Always seek advice from a tax professional, as there may be additional intricacies in how LLC owners get paid based on the specific services they provide to the company.

Tax Obligations for a Multi-Member LLC

If the limited liability company is taxed like a partnership, standard tax regulations apply to the company. This means that all taxes flow through to the owners, and the LLC’s income is subject to taxation on each member’s individual tax return.

The company is required to report deductible expenses and business income on IRS Form 1065. Subsequently, every member will detail their respective portion of partnership income on Schedule K-1. Every member is responsible for paying income taxes for their profit share. Members who are actively involved in the business must regard their portion of the profits as self-employment income.

Can an LLC member also be considered an employee?

As mentioned earlier, LLC members cannot be designated as employees if the company maintains its default tax status.

That said, if the company chooses to be taxed in the manner of a corporation, a member who participates actively in the LLC’s operations may be recognized as an employee. In this case, the business will directly pay taxes to the IRS, and the members may document all salaries, wages, and dividends on their individual tax returns.

Are there Tax Advantages to Opting for Corporate Taxation in an LLC?

For certain limited liability companies and their proprietors, electing S corporation tax status can lead to potential tax savings, especially if the company is engaged in an active business or trade and the owner faces high payroll taxes. Similarly, opting for C corp tax status may result in tax benefits, especially if the corporate tax rate is less than the members’ individual tax rate and/or there is no intent to make distributions.

A Note on Pass-Through Taxation

A primary reason why many small business owners choose to set up their companies as LLCs is because, for federal income tax purposes, it is a pass-through tax entity. This signifies that the LLC’s profits, losses, deductions, income, credits, and other tax items pass through to the owner(s). Unless the LLC elects to be taxed like a C Corp, it is not subject to entity-level taxation.

However, it is important to note that the pass-through status of the LLC does not imply that there are no tax considerations when running a business as an LLC. There might not be income tax liability at the federal level (unless you opt for C corporation taxation), an LLC with multiple owners is still required to file an information report. Additionally, the LLC may be accountable for various types of taxes and might need to submit various returns to local and state authorities.