How to Pay Yourself with an LLC
Your LLC is turning a profit and you’ve earned a payday—but how exactly do you pay yourself with an LLC? While LLCs allow for different payment possibilities, tax classification and number of members affect the options available to you. By default, the IRS taxes single-member LLCs like a sole proprietorship and multi-member LLCs as partnerships. LLCs can also be taxed as S or C corporations. Below, we go over how these factors determine how you can pay yourself as an LLC owner.
Paying Yourself in a Single-Member LLC
Have a single-member LLC? In the eyes of the IRS, you’re not an employee—and you don’t get a salary through payroll. Instead, you’re essentially taxed as a self-employed business owner. No matter whether you pay yourself or reinvest in your business, you’ll report all business income on your personal return and pay taxes (including social security and Medicare). To pay yourself after you start an LLC, you can make owner’s draws.
An owner’s draw allows you to take money from your business account and transfer it to personal funds. This can be accomplished by:
- writing a check to yourself
- withdrawing cash from a bank
- making an online transfer from your business account to a personal one
You can make these draws on a regular schedule, or simply as needed.
No matter how you choose to transfer the money, there must be a record of the transaction from a financial institution. For example, avoid accepting payments and depositing them directly into your personal account instead of your LLC account. Without a record, a court could rule your LLC liability protections invalid, putting your personal assets at risk. So leaving a paper trail for your owner’s draw is crucial.
Paying Yourself in a Multi-Member LLC
When your LLC has more than one owner, the means for paying yourself is a bit different. By default, multi-member LLCs are treated like partnerships by the IRS, which have a bit more flexibility than single-member LLCs. There are a few ways members can receive money from the business.
An LLC taxed as a partnership distributes profits to its members. This is often done with one lump sum at the end of the fiscal year. Distributions are typically proportional to each member’s percentage of ownership. Distribution details are usually included in the company’s operating agreement.
Since one payday a year can be inconvenient for many people, an LLC taxed as a partnership also allows members the option of collecting earnings through draws, much like a single-member LLC. While you can make multiple draws, the total amount of money a member can draw can’t exceed their share of the company’s profits.
Again, shares of profit are usually proportionate to ownership. So, if you owned 60% of the LLC, and annual profits were $100,000, you couldn’t withdraw more than $60,000 for that year. Besides the internal trouble this would cause, if the overdraw left the LLC with inadequate capital, the LLC could potentially lose liability protections.
Note that members pay income tax on their share of the company’s earnings. This means that members are on the hook for the full amount of income tax on their share, even if they only drew a partial amount of that share—or none at all. So in the example above, if you only paid yourself $25,000, you’d still owe taxes on all $60,000.
Owner’s Draws as Guaranteed Payments
Owner’s draws can also be set up as guaranteed payments. Guaranteed payments are minimum amounts paid on a schedule, whether the business is profitable or not. While not salary, guaranteed payments can provide members steady income no matter the LLC’s income.
Imagine a member arranged for $50,000 annually in guaranteed payments. One year, their share of the distribution of profit only comes to $35,000. The member would be entitled to an extra $15,000 to make up the difference.
To set up guaranteed payments, include specific provisions for each partner’s amount and payment schedule in your LLC operating agreement.
LLCs Taxed As S Corp / C Corp
Both single- and multi-member LLCs can elect to be taxed as C or S corporations by filing paperwork with the IRS. Corporate LLCs are required to have a payroll. Members providing any significant services to their LLC must be paid as salaried employees.
Members may also take a percentage of the corporate income in dividends or distributions, although how this occurs depends on whether your LLC is an S or C corp, as well as the terms laid out in your articles of organization or LLC operating agreement.
Paying Yourself From An LLC Taxed As C Corp
Members of LLCs taxed as C-corps can’t make owner’s draws from company funds. Instead, owners (much like shareholders in a traditional corporation) can receive regular dividends. These dividends are subject to corporate net income tax. Members also report the dividends on their personal returns, so dividend income is essentially taxed twice.
In addition, owners who work for the LLC must be are compensated through salary and can also receive bonuses. Be wary, however, of taking an excessive salary or bonuses. Because these forms of compensation aren’t taxed at the entity level, the IRS can view excessive salaries and bonuses as effectively disguising company profits to avoid “double taxation.”
Paying Yourself From An LLC Taxed As S Corp
Like in a C-corp LLC, members of an S-corp LLC who work for the LLC must be compensated through salary. Instead of dividends, members of an S-corp LLC receive distributions, typically in proportion to their membership interest.
As pass-through entities though, S-corp LLCs don’t pay corporate taxes. This means there’s no “double taxation” on distributions. Members may be tempted to take a low salary in favor of high distributions. However, the IRS requires S-corps to pay working owners “reasonable compensation” comparable to others in similar positions with similar experience in the area. So if you arrange for a meager $5,000 yearly salary with $75,000 in distributions, you can expect the IRS will notice.
Also unlike C-corps, S-corp members are allowed to make at-will withdrawals from company funds, similar to owner’s draws (but classified as distributions). But if you have multiple members, it’s important that distributions are not disproportionate to the member’s interest in the company. Otherwise, this can violate the requirement that S-corps can only have one class of stock, as uneven distributions are similar in effect to multiple types of stock.
Hiring Yourself as an Independent Contractor
Another option for self-compensation available to many LLCs is hiring yourself as an independent contractor for your company—such as contracting as a programmer for a software LLC you are a member of.
Hiring an independent contractor frees companies from obligations like withholding and limits the applicability of certain employment and labor laws. For contractors paid over $600, the LLC files a 1099-MISC. And, you’ll still have to pay self-employment taxes on whatever you earn as a contractor.
A company can deduct contractor payments, which allows for some additional financial flexibility—but there are risks, especially for LLCs taxed as C and S-corps. For LLCs taxed as C-corps, there is a risk of thepayments being reclassified as dividends if the IRS determines this is an attempt to disguise dividend payments, which are subject to double taxation. For LLCs taxed as S-corps, the IRS is wary of miscategorizing owner-employees as contractors to avoid employment taxes and the reasonable salary requirement.
In general, it’s wise to limit contracting yourself to specific projects where you have applicable skills, or even a separate business in that field. For example, contracting yourself to create a new logo for your LLC when you have a side business as a graphic designer. If you’re considering working for your own LLC as an independent contractor, it’s safest to first consult with a lawyer about potential legal ramifications.
Whether you decide to run your business in a way that provides a salary or relies on draws, distributions or dividends, choose a means of compensation that lets you cover personal expenses and justifies your time and effort. Hard work may be its own reward, but it shouldn’t be your only reward as an owner of an LLC.
Now that you know you can pay yourself…