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Best Ways to Pay Yourself from Your LLC
Our Guides Legal Services team will explain the different ways you can pay yourself from an LLC so you can get the most out of your business’s profits.
Take an Owner’s Draw (Profit Distributions)
Any owner of an LLC can be paid through profit distributions. Profit distributions are when the business profits get distributed among the members rather than reinvested into the business. These are sometimes called owner’s draws. The process for profit distribution is relatively simple for single-member LLCs. Since LLCs are pass-through entities, all you have to do is report the LLC profits and losses on Schedule C of your personal tax return.
If you have a multi-member LLC, this won’t be as simple as rerouting the money from the business to an individual member — that would cause a lot of tension among members. Multi-member LLCs should flesh out the process for how much and how often distributions can be given in their operating agreement.
Unlike the next method, owner’s draws require you to pay self-employment taxes on all the money that comes into your business. This will increase the amount of profits you lose to taxes each year.
Earn a Wage as a W-2 Employee
One of the most advantageous ways to get paid from your LLC is as a W-2 employee. Using this method, you will receive a regular paycheck as would an employee of any business. This is a good way to have a predictable income for your personal finances. As an LLC owner, this is also a good way to get paid because you will only have to pay self-employment taxes on the salary you have designated for yourself. This can save you about 15% on your taxes compared to if you were to just take distributions.
If you choose to pay yourself as a wage earner, there are some things you will need to keep in mind. First, the IRS considers employee wages to be a business expense that’s deductible from the business income. This means you will need to pay yourself according to the IRS’s rules.
One rule is that you must pay yourself “reasonable compensation.” This is not a specific dollar amount or formula you need to follow — just make sure you are paying yourself a reasonable salary within industry norms. Another rule is that you need to file IRS form W-4 to determine how much payroll is withheld from each of your paychecks. Keep in mind you will also pay income tax on any wages you receive.
Paying Yourself a Wage: Single-Member LLCs vs Multi-Member LLCs
If you own a single-member LLC, you cannot pay yourself as an employee unless you are actively working in the business. This means you can’t be a passive owner with zero responsibilities and still collect a wage from your LLC.
For example, John is the sole member of “John’s Goods, LLC.” John wanted to focus on his other businesses, so he delegated all the responsibilities of running John’s Goods, LLC to his manager, Mike. Since John is a passive owner that does not actively work in the business, he cannot pay himself a wage.
If there is more than one member of your LLC, each responsible for day-to-day operations, they must all be paid a wage or none of the members can. In other words, if you have a member-managed multi-member LLC, you can’t pay one member a salary and not the other.
Another example may help to clarify — John and Mike own and operate “J&M Goods, LLC” together. John wants to pay himself a wage, but Mike thinks all the profits should be reinvested back into the LLC. John cannot pay himself a wage unless Mike agrees to be paid a wage as well. But, if Mike steps back from managing the business, John can start paying himself a wage as long as he continues actively working for J&M Goods, LLC.
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Work as a 1099 Independent Contractor
For some LLC members, they can choose to get paid by hiring themselves as an independent contractor working for an LLC they happen to own. Although independent contractors don’t have payroll taxes taken out of their paycheck, you don’t end up saving any money on your taxes with this method. That’s because you end up paying the same amount you would save on payroll taxes when you pay your self-employment taxes every quarter.
For example, John owns an LLC and hires himself to create the business’ website. John can take a wage, or he can pay himself as an independent contractor. If John takes a wage, his weekly paycheck will be less than if he was an independent contractor. But John will owe less on his personal tax returns at the end of the year than if he was on a 1099. Either way, John is losing the same amount of company profits to taxes, just at different times.
This method is generally not recommended for small businesses since it achieves the same thing as other methods but requires strict bookkeeping. The only time this method can be beneficial is when you want to pay yourself as a passive business owner that doesn’t actively work for the LLC. That’s because you can’t pay yourself a wage unless you actively work for the business, so becoming an independent contractor is your only option.
Return All Profits to the Business
If you’re looking to aggressively grow your business, you may decide to not take a paycheck at all — and instead, reinvest all company profits back into the business. Even though the money is staying in the business, there are still some things you need to be aware of.
Remember, if you elected for your LLC to be taxed as an S corp you’ll still need to claim any company profits on your personal income tax return — even if you don’t take any wages or distributions. That’s because LLCs are treated as disregarded entities for tax purposes. So, any profit the company makes will pass through the entity and become your tax liability.
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Frequently Asked Questions
The best way to pay yourself as an LLC will depend on your specific circ*mstances. For most businesses however, the best way to minimize your tax liability is to pay yourself as an employee with a designated salary. This allows you to only pay self-employment taxes on the salary you gave yourself — rather than the entire business’ income.
If your lifestyle outgrows this designated salary, you can also take a year-end distribution as the business owner. So long as your company is generating enough profit, you don’t have to stick to just one method!
A common misconception about S-Corporations is that they are a type of business entity, like a corporation (also known as a C-corporation or C-Corp). However, an S-Corp is a tax status created by the Internal Revenue Service (IRS) to allow business owners to treat taxable income differently. Electing for your LLC to be taxed as an S-Corp means you won’t get double taxed — instead, your LLC is treated as a pass-through entity.
Self-employment taxes exist solely to fund the Social Security and Medicare programs. These taxes are automatically taken out of any employee’s paycheck, but if you’re self-employed you have to pay these taxes yourself.
Although you’ll never completely avoid this tax, you can lessen it by reducing your business’ net income. You can reduce your business’ net income by increasing business-related expenses. If you’re looking for the best strategy to minimize tax payments for your business, you should hire an experienced CPA that specializes in corporate tax.
Starting your own LLC is relatively simple, but can be overwhelming if it’s your first time. Our LLC set-up guides will give you all the information you need to do it yourself. If you want personalized advice on how to start your LLC in your state, there are some great LLC formation services that can take all the guesswork out of it for you.
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Legal Disclaimer: This article contains general legal information, but does not constitute professional legal advice for your particular situation and should not be interpreted as creating an attorney-client relationship. If you have legal questions, you should seek the advice of an attorney licensed in your jurisdiction.
If you have feedback or questions about this article, please email the MarketWatch Guides team ateditors@marketwatchguides.com.
