How to Pay Yourself from an LLC: 5 Options

How to pay yourself from an LLC in 5 different ways

So, how do you pay yourself from an LLC? The best method depends on how your business files taxes, its profitability, and your personal income needs. Most LLC owners pay themselves through a draw or guaranteed payments if their LLC files as a "pass-through" entity. Conversely, LLCs that file as corporations may pay owners a salary or distributions.

How to pay yourself with distributions

As pass-through entities, multi-member LLCs don't automatically pay corporate taxes. Instead, tax obligations "pass-through" to the business owner through their personal income tax return. The same is true for sole proprietorship, partnership, and single-member LLC members.

When deciding how to pay yourself in an LLC, consider taking distributions of business profits each year as personal assets. Each member owns a percentage of the LLC. Year-end distributions of an LLC's profits are made based on that percentage from the business account. So if the LLC had $100,000 in profit and you and the other member each own 50%, you can each receive $50,000. This would appear on your personal tax return.

It's important to note that receiving a salary and receiving year-end distributions are not mutually exclusive. If you get a paycheck, you're still a member of the LLC and entitled to your year-end distribution.

How to pay yourself with an owner’s draw

Owner draws are best for single-member LLCs or multi-members taxed as partnerships. They come from a business account set up for an owner when the company is formed. This account holds their initial contribution to the small business and amasses their share of the LLC's profits. The business entity can set the frequency of payments in its operating agreement.

For example, If you expect your percentage of the year-end LLC profits to be $12,000, you could set up a draw to receive $1,000 each month as personal assets from the business bank account. The total of all the draws throughout the year is deducted from the total year-end profit. So if your draw for the year totaled $12,000, but your share of the profit ends up being $15,000, then you would receive $3,000 at the end of the year.

To pay yourself through an owner's draw, write a check from the LLC to the business owner's personal bank account. Record the withdrawal as an owner's draw, along with the appropriate debit in the owner's business account. This periodic payment eliminates the need for payroll taxes and forms.

With this option, there's no need to withhold taxes on distribution payments, meaning there are no W-2 or W-4 (employee withholding) forms to deal with. Instead, you'll report your share of the business income on your personal tax return and pay self-employment taxes on it.

How to pay yourself a salary

Members of an LLC taxed as a C corporation (C corp) or an S corporation (S corp) can't make an owner's draw. Instead, the LLC can pay them a reasonable salary. Paying yourself from an LLC allows you to receive regular reasonable compensation throughout the year, which can be helpful if you are seeking a regular income. However, paying yourself wages requires working in the business and taking on operational responsibilities.

The advantage of acting as an employee of a C corp or S corp is that you can reduce your liability for self-employment taxes by paying yourself a reasonable salary while also receiving some more of your LLC profits as dividends.

The IRS defines a reasonable salary as the amount someone doing similar work would receive in the same industry and location. If your compensation exceeds the standard, the IRS may challenge it and reclassify some of your dividends as employee wages, which would increase your self-employment taxes. An LLC member who is an employee can take a bonus, but this must also be reasonable relative to their salary.

The disadvantage of paying yourself as an employee of a C corp or S corp is that you have to comply with various LLC payroll tax requirements, such as filing Form W-2, Form 941, Form 940, and state and local payroll tax returns. You also have to pay the employer's share of Social Security and Medicare taxes, federal unemployment tax (FUTA), state unemployment tax (SUTA), and workers' compensation insurance for yourself as well as other employees of your LLC.

How to pay yourself with guaranteed payments

Regular owners’ draws are effectively a pre-payment of profit, but you can also pay yourself LLC funds in the form of a guaranteed payment. These occur regardless of any LLC profits, making this arrangement more like a salary. Unlike an owner's draw, guaranteed payments are deductible business expenses for your LLC, reducing its taxable income.

The International Revenue Code defines guaranteed payments as payments that a partnership makes to a partner as compensation for capital, whether or not the partnership is profitable. If you want consistent income but don't want to become a full-time employee of your LLC, guaranteed payments may be the best option.

Guaranteed payments are particularly beneficial for multi-member LLCs that file taxes as partnerships. This is because partners pay self-employment taxes on guaranteed payments in the same way they pay income taxes. Meaning they can either deduct or capitalize on a guaranteed payment.

However, there are some tax complications to consider if you pay yourself with guaranteed payments. For example, if your fiscal year doesn't align with the calendar year, guaranteed payments from your current fiscal year can accidentally be included in the following year's tax returns, increasing that year's tax burden.

How to pay yourself dividends

If your LLC files as a C corporation and has profits left over after paying taxes, you're also eligible to receive dividends. Dividends are similar to distributions but come from cash profits rather than from a mutual fund. While you shouldn't pay yourself entirely in dividends, they can help to supplement your income.

The main disadvantage of dividends is that they're subject to "double taxation." This is because unlike distributions from LLCs that file as pass-through entities, C corporation dividends come from the left-over profit after your LLC has already paid corporate tax. In this instance they may also be taxable on a member's personal income tax.  

What are the benefits of starting an LLC?

A limited liability company is a simple business structure for small business owners to manage. It offers the same limited liability protection as a corporation without the rigid management. There are no requirements for annual meetings, minutes, or issuing stock certificates. You can decide how you want to run your business and how to distribute business profits and losses. You can also choose how to pay yourself in an LLC to optimize your personal finances and tax savings.

Limited liability companies also offer financial flexibility come tax season because, as a member, you can choose its legal designation for dealings with the IRS. For example, LLCs can choose to report business gains and losses on their individual tax return or on a corporate income tax return. Single-member LLCs are treated as sole proprietorships, and multi-member LLCs are partnerships by default. However, you can also choose to file as an S corporation or C corporation if it's more beneficial for your business. 

How to handle income tax on LLC pay

How you file income taxes varies based on how many members your LLC has and how you choose to be taxed. 

Income taxes for LLCs taxed as sole proprietorships

Single-member LLCs are not taxed. Instead, the sole member reports the income and expenses of the business on Schedule C of their IRS Form 1040 tax return. Owners in an LLC owe income tax on the amount their capital account amasses from the year's profits, regardless of how much they draw that year. 

An owner's draw does not affect the income taxes you pay on your total share of the profits. This means you owe income tax on your share of the LLC's profit—known as your distributive share—whether you draw it or not. So, if you leave some money in the business, perhaps to cover expansion costs, you are still liable for personal income tax on that amount.

Income taxes for LLCs taxed as partnerships

Similarly to a sole proprietorship, each member of a partnership multi-member LLC pays a portion of income tax on its earnings, whether a member draws it or not. The partnership must give each member an IRS Schedule K-1 (Form 1065) detailing their share of the business income. The LLC will also file Form 1065 to report partnership income to the IRS.

If all of the LLC members in a multi-member LLC participate equally in the operation of the business, you can't pay one a salary and not the others. However, if you are the only member who has a management role, you can pay yourself a salary without setting up salaries for the other participating LLC members.

Unlike with payroll in a C corp, an owner's draw is also not considered a deductible business expense for an LLC by the IRS, meaning it cannot be claimed against corporate tax.

Income taxes for LLCs taxed as C corps

LLCs can also elect to file taxes as corporations, if they prefer, through the filing of a Form 8832 with the IRS. However, it is important to consider the tax implications of this legal structure.

A C corp is double-taxed. It must pay income tax to the IRS, and those taking wages or dividends from it also pay personal income tax on those earnings. While a C corp LLC can be disadvantageous for those drawing regular income, it can be a useful structure for higher net-worth members planning to leave capital in the business. C corp taxation rates are often lower than the higher-level personal tax rate, creating an opportunity for tax savings.

Income taxes for LLCs taxed as S corps

Qualifying multi-member LLCs can also designate themselves as an S corp. An S corp is a pass-through entity and does not pay taxes at the federal level. To qualify as an S corp, an LLC must be a U.S.-based business and cannot have more than 100 owners. Neither can an S corp have a corporation or partnership among its members or carry multiple stock classes.

If you choose to pay yourself a salary from your LLC as an employee, you will pay income tax on your wages earned, and the LLC must file a W-2 form to show the IRS your payments and withheld taxes. You'll need to file IRS Form W-4 to determine the amount of income tax that the LLC should withhold from your paychecks. This will also incur LLC payroll taxes.

One advantage of paying yourself a salary as a member is that wages are considered operating expenses for the LLC, enabling members to deduct them from the LLC's profits for tax purposes. The IRS only allows reasonable wages as a deduction for corporate tax.

A special note about self-employment taxes for LLC owners

Typically, a company pays half of an employee's taxes (known as FICA taxes) that contribute to Social Security and Medicare. The employee pays the other half. For an LLC, how you pay FICA taxes varies based on your filing status. 

Self-employment taxes for pass-through entities

An LLC business owner who's not considered an employee must pay half of the FICA taxes that would normally be paid by an employer. This taxation applies to their entire distributive share, although as self-employed people they can generally claim half of the self-employment taxes they pay as a business expense to make some tax savings.

Self-employment taxes only apply to active members who participate materially in the operation of an LLC. Passive members, who don't participate, don't pay this tax.

Self-employment taxes for LLCs that file as corporations

Members of C corp LLCs can pay half of their FICA taxes through the LLC but must cope with the double taxation issue. Alternatively, members of S corp LLCs can avoid double taxation while also paying their half of the employee member's self-employment tax through the LLC.

Members working as contractors must pay self-employment taxes on the contractor fees from the LLC.

FAQs

What’s the best way to pay yourself from an LLC?

The best way to pay yourself from an LLC depends on the size and structure of your business as well as which benefits are most important to you. For example, paying yourself through a draw or distributions may be more beneficial for small business owners looking to reduce their tax burden. However, the steady income of a salary may be more beneficial if you're applying for a mortgage or loan.

Do you get taxed twice if you pay yourself from an LLC?

LLCs that file as C corporations are subject to double taxation and, therefore, may have to pay taxes on the same profits at a corporate and individual level. Alternatively, LLCs that file as a pass-through entity only pay individual income tax on business profits but must pay both the employee and employer portion of self-employment tax.

What are some of the best tax deductions for an LLC?

There are several tax deductions for LLCs that can help your small business save money without cutting into operational expenses, including rental expenses, charitable donations, depreciation, payroll taxes, cost of goods sold, and business insurance.

What are the benefits of paying yourself from an LLC?

Paying yourself through an LLC can help you to separate your personal and business profits and can also offer various tax benefits depending on what type of entity you file as and how you choose to pay yourself as an LLC. 

Danny Bradbury and Brette Sember, J.D., contributed to this article.