Limited liability companies are the most popular business structure, but it may be confusing to understand how you pay yourself. How you pay yourself varies depending on whether you’re a single-member LLC or a multi-member LLC. The Internal Revenue Service (IRS) has stringent rules governing how LLC members get paid and how those earnings are classified and reported on your tax election/tax return.
Typically, an LLC is taxed as a sole proprietorship (single member) or a partnership (multi-member), but there are other classifications. You could also elect for your LLC to be taxed as an S-corporation. If your LLC pays taxes according to the usual rules, members aren’t considered employees and don’t receive salaries. However, if you choose for your LLC to be taxed as a corporation, members who actively work for the LLC may be considered employees and eligible for a salary. In this article, we’ll explore the most common ways you can be paid as part of an LLC, per the default rules.
Getting paid as a single-member LLC
When you’re a single member of the LLC, it’s considered a single-member LLC and is taxed as a sole proprietorship (except for S-corporation status). However, you won’t be paid like a sole proprietor when your business earnings are your salary; instead, you’ll be paid through an owner’s draw. This happens when you withdraw funds from the business as personal funds. This is done by transferring money from your business bank account to your personal account or writing yourself a business check.
Tax requirements for a single-member LLC
Your business will be taxed on all profits, no matter how much you ”draw” as a salary. If you don’t elect corporation status, the IRS considers your LLC a ”disregarded entity,” which means the business and owner aren’t separate. All LLC profits and losses are reported on the owner’s personal tax return.
What about payroll taxes?
Since you’re not considered an employee but inextricable from the business for tax purposes, social security contributions and medicare aren’t withheld. Instead, you report and pay self-employment taxes like a sole proprietor. You may be considered an employee if you choose to be taxed as a corporation. You’ll receive ”reasonable compensation’’ as a salary, and income taxes, medicare, social security, etc., will be withheld.
Getting paid as a multi-member LLC
Unless you elect to be treated as an S-corp for tax purposes, you’ll be treated as a partner in a general partnership. Every member has a capital account, and to receive income, LLC members draw from their capital account. Payments are typically made by business checks, though members of an LLC can also receive a non-salary ”guaranteed payment”, basically, a payment they receive regardless of any net income earned in that quarter.
This protects cash flow for every member during slow or unprofitable periods. Your LLC operating agreement should stipulate how payments are made and distributed. You can also set rules around the payment schedule, if a vote is required, etc. You should agree with each member, as there are different ways to do it. Profits can be divided based on ownership percentage, equally, etc. This ensures cash flow for each LLC member during unprofitable periods. If you don’t allow for this in your operating agreement, default provisions in the LLC statute will apply. You should always consider consulting a tax professional, as the nuances of this issue can be complex.
Tax requirements for a multi-member LLC
Suppose your LLC is taxed like a partnership; the standard tax rules apply, meaning that all taxes pass through to each member, and LLC income is taxed on each individual’s tax return. The LLC must use IRS Form 1065 to report business income and expenses, and then each member uses Schedule K-1 to show their share of income and pay income taxes on their share. Members who work for the company actively can treat their share of the profit as self-employment income.
Can the owner of an LLC be an employee?
As mentioned, LLC members can’t be classed as employees if the LLC is in default tax status. However, if an LLC opts for S-corp taxation, a member who works for the LLC can be considered an employee – the company pays taxes to the IRS. Members can report all salaries, business expenses, dividends, wages, etc., on their personal tax returns.
Are there tax benefits to having an LLC taxed as a corporation?
Being taxed as an S-corporation can provide tax savings – particularly if the LLC operates an active business and payroll taxes are high. C-corporation status may provide savings, as corporate taxes could be lower.
One of the core reasons LLCs are so popular is that small business owners can structure their taxation to be passed through, meaning that LLC’s gains, income, deductions, credits, losses, and other tax benefits pass through to the individual’s tax return. The LLC isn’t subject to entity-level taxes unless it elects corporation status.
However, the LLCs pass-through taxation doesn’t mean no tax considerations are involved in operating the company as an LLC. While there are no entity-level federal taxes (unless you elect C-corporation status), a multi-member LLC must still file a report, and the LLC may be liable for other tax types. S-corporations avoid double taxation, too, combining the benefits of a traditional corporation and LLC taxation. Entrepreneurs will pay end-of-the-year taxes on their personal income tax returns.
LLCs are a popular business structure, and though it seems complex, taxation is usually handled simply as taxable income passed through to the member(s) individual tax return. However, there are exceptions to this rule. You may be paid as an employee if your LLC has elected corporation status. You should always consult a tax advisor before making any binding decisions concerning taxation.