If you own a limited liability company, or an LLC, how you pay yourself depends on how your organization is taxed.
LLCs are unusual business structures which combine positive aspects of both sole proprietorship and corporations. They offer protection against personal liability while allowing you to record profits and losses on your personal income tax return. However, LLC members can choose to be taxed as corporations.
Here’s how to pay yourself as an owner of an LLC.
Owner’s draws and guaranteed payments
Owner’s draws are the most common way to pay yourself as an LLC. If you’re a single-member LLC, the IRS views your business as a “disregarded entity.” That means that your LLC profits are considered personal income for purposes of taxation. Rather than paying yourself a salary, you take an “owner’s draw” at whichever amount and frequency you choose. (However, it’s important to keep some money in the business to continue operations.)
Multi-member LLCs can use owner’s draws as well as guaranteed payments. Because LLCs are classified as partnerships and pass-through entities, the business income is reported but not taxed. Each member’s share of the profits is taxed as their personal income. Multi-member LLCs pay themselves through owner’s draws, leaving some funds for business expenses. If the company is particularly successful, the LLC members can set up guaranteed payments, which function similar to salaries.
Corporate salary and distributions
If your LLC is treated as an S-corporation or a C-corporation, the members are now known as shareholders—and they’re not allowed to take owner’s draws. Instead, the LLC shareholders are considered employees of the company. Shareholders pay themselves a salary and withhold payroll taxes appropriately.
When determining your corporate salary, keep in mind that it needs to be “reasonable.” That is, you should pay yourself similarly to what others would pay for similar services offered by similar corporations in similar circumstances. In other words, if own a small independent bookstore and outsource most of the duties to employees and other providers, a million-dollar salary is likely not reasonable compensation.
However, you can also decide to pay yourself dividends or distributions. Remember that while they aren’t subject to payroll taxes, they are taxable income.
Which business structure should I choose?
Choosing your business structure is one of the most important parts of founding a company. Not only will it affect how you’re paid as an owner, member or shareholder, there are also personal liability implications.
LLCs are a popular structure for small businesses because they offer many of the benefits of corporations without the complexity—unless you opt to be treated as a corporation for tax purposes. Before you make any major decisions, it’s always wise to talk to a bookkeeping and tax preparation professional. They can help you understand what to expect when paying yourself and filing business taxes, so you don’t make any costly mistakes.
For more information about LLC bookkeeping, income and tax preparation considerations, team up with the professionals at MCG Solutions. Call today to get started.