A common question that business owners ask is: How do you pay yourself? Depending on how you set up your business, the question may be how do you pay yourself from an LLC, sole proprietorship, S corps, or other business structure.
The type of business entity you run will impact how you pay yourself and your taxes. If you’re wondering how you pay yourself from an LLC, we’ve compiled this guide to help.
Table of contents
- What is an LLC?
- Types of LLCs
- Which LLC Structure Should You Use?
- The Owner’s Draw
- How Do You Pay Yourself From a Single-Member LLC
- Paying Yourself as a Multi-Member LLC
- How Much Should You Pay Yourself
- How to Pay Taxes as an LLC
What Is an LLC?
A limited liability company, or LLC, is a type of business structure that offers its owners limited liability protection. It means that the owners are not personally liable for the debts and liabilities of the business.
To form an LLC, a business must file the appropriate paperwork and register with the state in which the business will be operating. You should also choose a name for your business that includes the designation “LLC.”
Once you have done this, you will need to create an operating agreement that outlines your company’s rules and regulations. By taking these steps, you can ensure that your LLC is properly formed and protected.
Types of LLCs
There are several types of LLC arrangements, and there are also tax considerations for each one.
- Single-member LLCs: These LLCs have only one owner (member) and the income from the business is reported on Schedule C of the owner’s individual tax return. The business is taxed in the same manner as a sole proprietorship.
- Multi-member LLCs: These LLCs have several owners (members) and report their income and expenses on a partnership tax return. Each owner receives a K-1 at the end of the year which contains their share of the business income.
- Corporation: LLCs have the option of being taxed as a corporation (either an S corp or a C corp) and completing the applicable corporate tax return. C corporations pay tax at the corporate level. S corporations are pass-through entities and the owners pay taxes on their share of the profits.
Which LLC Structure Should You Use?
Choosing the right type of LLC structure will depend on your personal financial circumstances and the number of owners. Single-member LLCs must be taxed as either a sole proprietorship or as a corporation. Multi-member LLCs must be taxed as either a partnership or a corporation.
The advantage of a multi-member LLC is that it provides its owners with the personal asset protection of a corporation while still allowing them to enjoy the tax benefits of a partnership.
However, to maintain the protection of an LLC, it is important to keep your business and personal finances separate. For example, the business should have a separate bank account to receive payments from clients. Owners should not pay personal expenses from the business accounts.
The LLC (limited liability company) is a popular alternative to a sole proprietorship set-up for single-owner businesses.
It gives you the same simplified income processing that a sole proprietorship enjoys, plus financial and legal protection similar to a corporation.
Here’s how you handle the owner’s salary and taxes for a single-member LLC.
The Owner’s Draw
Typically, you pay yourself from an LLC through an owner’s draw. However, because different types of business structures can fall under LLC, it varies. Let’s look at the specifics.
What Is an Owner’s Draw?
An owner’s draw is a distribution of funds from an LLC to one or more of the owners. LLCs are often created for liability purposes, but once the business has been established, the IRS will require tax reporting of the business activity.
The IRS requires that LLCs keep separate records for business and personal expenses. An owner’s draw allows owners to access the funds from it without having to pay taxes on those funds.
However, LLCs are not required to make owner’s draws, and they may instead choose to reinvest the funds back into the business.
The amount that an owner draws from an LLC is at the discretion of the owner. The distribution of funds does not create a taxable event since the owner is taxed on the profit of the business, not how much money is transferred to the owner.
The owner is responsible for determining how much working capital needs to be left in the business to meet future obligations and fund the company’s growth.
How Do You Pay Yourself From a Single-Member LLC
A single-member LLC can be treated the same as a sole proprietorship — as long as you choose to be taxed that way and not as a corporation.
To pay yourself from a single-member LLC, you take money out of the company’s profits whenever you need it. It’s what’s called the owner’s draw, and you can take it out simply by writing yourself a check or using payroll software.
How to record owner’s draws
The most important thing about owner’s draws is ensuring that you properly document the draws. Also, to maintain the LLC protection, the owner must keep their finances separate from the company’s finances. Otherwise, the company may lose its liability protection and put the owner’s other assets at risk in the event of a lawsuit.
You do not want the payments to be miscategorized. If you transfer money directly between your business and personal accounts, you should label the transactions. You can add a memo if your bank allows it or document the transaction in your accounting software.
For bookkeeping purposes, create a “drawing account” on your balance sheet. Whenever you take money out of the company, enter it as a debit in the drawing account. Then, enter the same amount as a credit in your personal account.
The owner of a single-member LLC is not considered an owner, so you pay yourself as an employee. Payroll taxes are calculated on the net income of the business and paid on the owner’s individual tax return. The owner’s total income determines the income tax rate. On the other hand, the self-employment tax rate is currently at 15.3% for all self-employment income.
Below is an example of the journal entries for an owner’s draw of $20,000 withdrawn from the company’s bank account.
|Cash in Bank (Company Account)||$20,000|
Paying Yourself as a Multi-Member LLC
How you pay yourself as a multi-member LLC depends on how you are taxed. As noted above, multi-member LLCs are either taxed as partnerships or corporations.
You’ll also need to take into account the different ownership interests when distributing profits and losses.
1. Determine contributions
The first step is determining how much each member has contributed to the LLC. You can do this by looking at the initial investment, as well as any subsequent contributions. Once you have this information, you can then determine what percentage of the LLC each member owns.
2. Decide on how to distribute profits and losses
The next step is to decide how you will distribute the profits and losses of the LLC. There are several options for determining how to distribute profits. One way is to distribute the profits and losses proportionally to each member’s ownership interest. However, you can also choose to distribute them to reflect each member’s contribution to the business. For example, if one member contributed more capital, you may want to give that member a larger share of the profits.
Note that in partnerships, there is no requirement for distributions to be equal or fair. Your business must complete distributions according to any partnership agreements in place at the time.
3. Set up a draw account
Once you’ve determined how to distribute the profits and losses, you can start paying yourself (and your partners) from the LLC.
The easiest way to track funds distributed is to set up a draw account for each member. You’ll need to keep track of all withdrawals so that you don’t overspend or cause problems for the LLC down the road. At the end of the year, you’ll report the amount distributed to each partner on the partnership return.
Partnerships track each partner’s net investment in the company on the partner’s K-1. The net investment includes the partner’s initial investment plus any subsequent investment plus any income from the business less any distributions. The partners’ net investment (also known as a basis) can affect how the partnership income (or loss) is taxed on their return.
If you were the owner of an S Corporation, you would have to pay yourself a salary as if you were any other W-2 employee. The IRS requires that you pay yourself a reasonable salary, although it does not offer guidance on what that means.
To pay yourself from a corporation, you need to create a separate bank account. Also, you need to use a payroll system and withhold, report, and submit payroll taxes.
S corporations are only allowed to have one class of stock. Because of this requirement, any distributions taken from an S corporation must be proportional to the shareholder’s stock ownership percentage.
For example, consider an S corporation with two shareholders where one owns 40% of the stock while the other owns the remaining 60%. If the shareholders wanted to distribute $10,000, the first shareholder would have to receive $4,000, and the second shareholder would need to receive $6,000.
C corporations can have multiple classes of stock and, therefore, are not subject to the same restrictions requiring proportional distributions as S corporations. Distributions from C corporations are taxed as dividends on the shareholder’s income tax return.
How Much Should You Pay Yourself as an LLC?
There are a few factors to consider when setting your salary, including the type of LLC, the profitability of the business, and your personal financial needs.
For example, if you have a single-member LLC that is not generating much income, it may not be necessary (or possible) to draw a salary. If you have a multi-member LLC that is profitable, you have to decide how to divide the profits among members.
In addition, you also need to take into account your personal financial needs. If you have a low cost of living, you may be able to get by with a lower salary. However, if your expenses are high, pay yourself accordingly.
Ultimately, there is no single answer to this question. The amount you pay yourself should be based on a variety of factors specific to your business and your personal circumstances.
You’ll want to ensure that you leave enough funds in the company’s account to cover future operations and obligations.
Note that if your LLC is taxed as an S corporation, then you are required to pay yourself a salary for services rendered. If the LLC does not pay the owner a reasonable salary, the IRS has the authority to reclassify any distributions as salary. As a result, they may impose payroll taxes on the distributions.
How to Pay Taxes as a Single-Member LLC
The IRS classifies a single-member LLC as a “disregarded entity,” with basically the same rules as a sole proprietorship. That means you won’t have to file separate tax returns for your business and personal income.
Instead, the business profits and losses are “passed through” to your personal account. You’ll report them on your personal federal tax return — IRS Form 1040, generally with Schedule C, E, or F.
The one drawback to this situation is that you will have to pay the full amount of payroll taxes (Social Security and Medicare) by yourself.
How to Pay Taxes as a Multi-Member LLC
If your business were a corporation, you’d split the cost of payroll half-and-half with your “employer.” C corporations will pay taxes on their income at the corporate level while S corporation profits are taxed on the owner’s individual tax returns. Some states tax S corporations so you’ll need to check on the rules in your state.
Businesses taxed as partnerships will pay income and self-employment taxes on their individual tax returns.
Owners of LLCs—taxed as S corporations or partnerships—need to make estimated tax payments throughout the year. Business distributions you receive do not have taxes withheld, so you need to report it.
Your estimated tax payments are based on your projected tax liability for the year. If you do not pay the required estimated taxes for your individual return, you may be subject to interest and penalties on the underpayment amount.
Still not sure about the ins and outs of bookkeeping, paying yourself, or preparing your tax return as an LLC?
Our small business experts can answer your questions and help you decide what’s best for you and your business. Xendoo’s mission is to take those hassles off your shoulders, so you can concentrate on making your business thrive. View our plans here.