How to Pay Yourself as an LLC

We believe it’s fair to say that small business owners usually open their doors because they hope to make a living from their work.

Once business owners choose to open an LLC over other business types, a question that often comes up is, How do I pay myself from my LLC?

It’s not a cut-and-dry question to answer, given all the different tax classifications and options available to you as an LLC owner when you set up your business.

Another factor that can impact how you handle paying yourself is if you own a multi-member LLC or a single-member LLC, and whether there’s managers.

Picking what’s right for your small business can only happen if you have the facts about the most common options: owner draws and salaries.

We’ve got you covered!

Understanding LLC Structures

When you start a business, you have an important decision to make — what type of business do you want to establish?

As a business owner, you have the choice between a sole proprietorship, partnership, LLC (limited liability company), and corporation.

There are pros and cons to each type, but the LLC shares characteristics with C corporations (or C corps) and partnerships/sole proprietorships.

LLC owners, called members, have the advantage of flexibility. They can choose how to organize and run the business and decide to manage it themselves or hire a manager. This flexibility also extends to how members get paid.

An LLC can be treated in three different ways for income tax purposes: as a disregarded entity, a partnership, or a corporation:

• If the LLC has one member, it's treated as a disregarded entity for tax purposes by default. Business income is reported on the member's personal income tax return, making it easy to pay yourself from the profits. Once the LLC has an EIN, members can apply for a different classification.
• If the LLC has multiple members, the default for tax purposes is to treat it as a partnership. The profits are divided among members, who then report their share on their personal income tax returns. The LLC can also opt to be taxed as an S-Corp or C-Corp by applying for this classification.
• The LLC can choose to be taxed as a corporation. The LLC pays its own taxes and then pays members as employees (salary) or shareholders (dividends).

Understanding your options will help you decide the best way to pay yourself and manage your taxes.

Owner’s Draw

The owner's draw method is a simple way for LLC owners to withdraw money from the business without incurring the expense of setting up payroll. It works well for LLCs treated as disregarded entities or partnerships.

As a first point, It is important to understand the difference betweenincome allocations and cash distributions.

We often think of them as the same thing, but they are quite different.

An income allocation is an owner’s share of the profits of the company after business deductions like general expenses and depreciation. The income allocation will be listed on a schedule of an owner’s personal tax return if there is only one owner or on the LLC owner’s K1 if the LLC is a partnership. Income allocation is taxable, but how it is taxed will vary based on the character of the income.

Certain allocated income is included in “self employment” income and will be subject to self-employment taxes. Other income is excluded from self-employment income (such as capital gains and dividends) and is not subject to self-employment tax. For more information about exclusions, visit the IRS website.

Distributions from an LLC are not by themselves automatically taxable or subject to self-employment taxes. As an example, let’s say you contributed $100,000 to your business (expecting the business to earn money quickly), you found that generating income is taking longer than you planned. You can distribute a portion of the $100,000 you initially contributed without paying any taxes on the distribution because the company has not generated any taxable income.

In multimember LLCs, each owner can take a draw based on their profit share. Note: How the distribution is handled between members should be outlined in the LLC’s operating agreement. Again, the money distributed may or may not be taxable to the owners and reported to them on a K1 depending on the LLC’s income allocation.

The owner's draw method is easy and convenient, but the downside is that it can be difficult to determine if the money taken out will be subject to self-employment taxes. These include Social Security and Medicare taxes, which can add up quickly if the income is subject to self-employment tax. If the owners fail to send self-employment tax to the IRS, they can be hit with penalties or if they overpay, they will lose access to that money until they file a personal tax return and request a tax refund. That’s why tax planning is essential.

It's advised to keep accurate records of your draws and plan for tax payments so you don't get caught off guard. This way, you can enjoy the simplicity of the owner's draw method without any surprises at tax time.

Salary Payments

When an LLC is taxed as a corporation, owners can pay themselves a salary from the LLC’s income. This method is a bit more complicated than the owner's draw method because it requires setting up a payroll system.

You’ll need to treat yourself like an employee:

• Decide your salary.
• Keep track of payments.
• Withhold taxes, including federal income tax, Social Security, and Medicare taxes.
• Pay employer payroll taxes. This includes matching Social Security and Medicare taxes.

A key part of paying yourself a salary is the idea of "reasonable compensation." This is required by the IRS so that business owners don't underpay themselves to avoid payroll taxes. Pay yourself an amount that reflects the work you do, similar to what others in your industry get paid for the same job.

There are a few steps involved in setting up payroll for an LLC:

• Get an Employer Identification Number (EIN) from the IRS if you don't already have one. Apply for one with the IRS through their website or submit Form SS-4 by mail or fax. (Need a hand with this process? LLC Attorney has you covered!)
• Choose a payroll system.You can handle payroll in-house with software like Quickbooks, or hire a payroll service.
• Calculate your payroll taxes, and withhold them from your salary.These taxes include federal income tax, Social Security, Medicare, and sometimes state and local taxes. File payroll tax reports regularly and send the withheld taxes to the IRS and other tax agencies.

The salary payment method for LLCs taxed like a C corporation involves more steps than the owner's draw method. Even though it's more work, the salary approach can help you manage your taxes better and keep your business running smoothly.

Note: If you’ve created a multimember LLC, you can’t pay one member a salary and not the others. It might be best to consult a tax professional for professional advice based on your needs.

Tax Implications and Reporting

An LLC is a type of pass-through entity, which means that business income goes directly to the members. The advantage here is that (unlike owners of a C corporation, who get taxed at the corporate tax rate and again when they file their personal taxes), you can avoid double taxation.

Still, when you own an LLC, your choice to pay yourself through owner draw or salary affects your taxes and how you report your income.

Owner’s Draws:

• Tax Implications: You are responsible for self-employment taxes, which include Social Security and Medicare. This can get expensive depending on how much of the business income is subject to taxation.
• Reporting:You don’t have to withhold taxes when you draw. Instead, you need to make quarterly estimated tax payments to the IRS. This will prevent a big tax bill at the end of the year.

Salary Payments:

• Tax Implications: Salaries are subject to payroll taxes (federal income, FICA, Social Security, and Medicare).
• Reporting: You need to set up payroll, which means calculating and withholding these taxes from your paycheck. You’ll need to file quarterly payroll tax reports and send the withheld taxes to the IRS.

For Owner's Draws

If you choose to take draws from your LLC, it’s important to understand your tax responsibilities, especially self-employment tax and quarterly estimated payments.

Self-Employment Taxes and Quarterly Payments

When you take a draw, you must pay self-employment taxes to cover FICA taxes (Social Security and Medicare). If you’re employed, these taxes are paid for on your paycheck. Not now — you're the boss!

Since draws don’t have taxes automatically taken out, you need to pay estimated taxes every quarter to cover your federal income tax and self-employment tax.

The IRS expects you to pay these taxes throughout the year instead of waiting until you file your annual tax return. To make it easier, they've created IRS Form 1040-ES to help you figure out what and how to pay. You can also seek out a tax professional or accountant.

Here’s a quick guide on how to handle quarterly estimated payments:

1. Calculate your earnings:Figure out how much you expect to make for the year. Include all income.
2. Estimate taxes: Use your expected earnings to estimate how much tax you owe.
3. Pay quarterly:Divide your estimated taxes by four. This gives you the amount to pay each quarter. The due dates are usually in April, June, September, and January.
4. Keep accurate records:Always track how much you draw from your LLC and your estimated tax payments so you can stay organized and ready for tax time.

The takeaway here is this: Planning ahead for taxes and paying on time when you own a small business is key. If you don’t pay enough in quarterly estimated payments, you could face penalties. It's simple to avoid — stay on top of your earnings and set aside enough money for taxes.

By understanding self-employment tax and making quarterly estimated payments, you can avoid surprises, keep your business in good standing, and fulfill your tax responsibilities.

For Salary Payments

When you elect to pay yourself a salary from your LLC, especially if it's taxed as a corporation, it's important to:

• Withhold taxes correctly.
• Ensure your salary is reasonable.
• Comply with IRS requirements.

Withholding Taxes

When you take a salary from an LLC, you’ll need to treat yourself as an employee and withhold taxes, including:

• Federal income tax: The amount depends on your salary amount and the information on your W-4 form.
• Social Security and Medicare Taxes (FICA): You withhold a portion from your salary, and your LLC matches that amount.

Reasonable Compensation

The IRS requires you to pay yourself a "reasonable salary" — similar to what others in your industry earn for doing the same work. The IRS looks at various factors to decide if your salary is reasonable, such as:

• Your role and responsibilities.
• How much time you spend working for the LLC.
• The going rate for similar jobs in your industry and area.

Compliance with IRS Regulations

To stay compliant with government regulations, you need to:

1. Use payroll software or hire a payroll service to help you with calculations and tax withholdings.
2. Withhold the right amounts for federal income tax, Social Security, and Medicare.
3. File payroll tax reports quarterly. IRS Form 941 will help you calculate and pay the correct amount.
4. Send the withheld taxes to the IRS on time. Depending on the size of your payroll, this is usually done monthly or semiweekly.

If you don't follow these steps, you leave your LLC open to an audit, leading to penalties and extra taxes. Even if you don't get penalized, audits are a stressful, time-consuming headache, so do what you can to avoid it.

Factors to Consider When Deciding Payment Method

Choosing between a salary and draws can be tough! Still, you have an advantage here. As an entrepreneur who owns an LLC, you get to choose what's best for you and your business.

Ultimately, your choice should depend on several factors, such as:

• How much control you want over your income. Salaries are stable, but draws give more flexibility.
• If you have a single-member LLC or multimember LLC. You can’t choose to have some members on owner draws and others on salary, so everyone needs to agree.
• The financial health of your LLC. If your business has reliable income, a salary could work for you. If your business income is unsteady, you can draw more or less of the company’s profits where it makes sense.
• Your business growth objectives. If you plan to reinvest profits into the business, draws might be a better choice.

Considering the above can help you decide the best way to pay yourself while maximizing tax benefits and doing what’s right for your LLC.

How Much Should You Pay Yourself from Your LLC?

Deciding a reasonable pay for yourself from your LLC involves looking at a few key factors.

First, consider your personal financial needs. You need to earn enough to cover your living expenses and savings.

Next, ask:How profitable is my LLC? Review your earnings and your business expenses. If the numbers make sense, you can afford to pay yourself more.

Then, research what people in similar roles and businesses get paid.

The goal with a reasonable salary is for the numbers to make sense. If the IRS sees your salary is $20,000 for a role that typically earns $80,000, they may want to take a closer look (they may think you're hiding taxable income, so you don’t pay income tax).

A salary that considers the above points will help you pay yourself fairly and keep the IRS happy. For help getting to that number, seek out an accountant or financial advisor.

Legal and Financial Compliance

Following IRS rules and laws is essential if you want your LLC to stay in good standing, prevent fines or legal trouble, and avoid losing personal liability protection.

To do this, set up proper accounting systems. Either use accounting software or hire an accountant to keep track of your money. Other benefits to setting up accounting systems are easily viewing your finances making tax time easier.

Also, be sure to keep meticulous financial records. Save all your receipts, invoices, and financial statements.

The goal is to stay organized so you can make tax time easier and prove your income and expenses when needed.

Bottom Line: How to Pay Yourself from an LLC

Choosing how to pay yourself from your LLC should be based on your individual and business needs.

When deciding between a salary and owner draw setup, consider:

• Tax and reporting responsibilities.
• How much control you want over your income.
• The financial health of your LLC.
• The other members of your LLC (if any).
• Your business growth goals.

Understanding how these factors can affect your business is essential for getting the answer to our question: How do I pay myself from my LLC?

One method isn’t inherently better than the other, so ask questions and choose what best aligns with your needs and supports your LLC’s success. We encourage you to seek the advice of an accountant or financial advisor for professional input on the best choice for you.

Paying Yourself from an LLC FAQs

How does an LLC member take a salary or withdraw profits from the business?

To take a salary, you first need to determine a reasonable salary and then set up a payroll system. You’ll also need to withhold taxes and remit quarterly payments to the IRS.

To take owner draws, move funds from your business bank account to your personal bank account as needed. You’ll need to pay self-employment taxes and keep up with quarterly tax installments.

How am I taxed as the owner of a single-member LLC?

As the only owner of an LLC, your decision on how you pay yourself will affect how you’re taxed. If you choose to take owner draws, you’re responsible for self-employment taxes to cover FICA taxes (Social Security and Medicare).

If you choose salary, you’re responsible for federal income and FICA taxes.

How do I set up a salary for myself from my LLC?

To set up a salary from your LLC, you’ll need to treat yourself as an employee. You’ll need to withhold taxes, decide on a reasonable salary for your role in the LLC, and set up a payroll system. Use payroll software or hire a payroll service to help you with calculations and tax withholdings.

How are owner’s draws taxed?

You must pay self-employment taxes, which cover Social Security and Medicare, on all your business earnings. You don't need to withhold taxes each time you take a draw. Instead, you need to make quarterly estimated tax payments to the IRS to avoid a large tax bill at the end of the year.