If you are starting your own business, you will eventually start to wonder how to pay yourself, LLC-wise. You may be the owner - but you still need to get your business income for what you are doing. After all, bills do not pay themselves.
Luckily, there are multiple ways through which an LLC owner can cover their payment. You can treat yourself as your own employee, as long as you consider the factors and tax implications.
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A limited liability company, also referred to as an LLC, combines the advantages of sole proprietorships with those of a corporation. While a sole proprietor has their personal assets liable in the event of business failure, LLCs have limited liability protection. In other words, their assets are protected from being seized.
The rules on how an LLC works will differ from state to state (read which states are the best to open an LLC). That being said, LLC owners are typically labeled as LLC members.
LLCs also have better tax flexibility as compared to a corporation. For example, an LLC member can decide to pay income taxes as a sole proprietorship, or they may do so as a corporation. They may choose the option that works to their advantage.
There are different kinds of LLC out there, and these types may affect the way you get your payments. Here is what you may choose from:
A single-member LLC is similar to a sole proprietorship. Like its name suggests, has only one member: the owner. They are responsible for handling the taxes, transactions and business debts.
Since it is one of the most affordable LLC options, the LLC's profits in this case are more convenient. A single-member LLC can also form a partnership with other people, while maintaining their role as the owner.
Unlike a single-member LLC that has only one member, a multi-member LLC is a business entity in which responsibilities are spread among multiple partners.
A multi-member LLC can also act as a limited partnership, where just one member retains personal liability. A partnership agreement will be drafted so that everyone knows what their responsibilities are.
A general partnership is typically the preferred structure for a small or medium-sized company. General partnerships are LLCs where two people sign a business agreement.
As an LLC owner, there are several ways in which you can pay yourself. Here are the most common options. Bear in mind that the option you go for may not only affect your personal taxes but also your business taxes.
The most common option for paying yourself as an LLC owner is to get an owner's draw - which means that you are drawing from company's profits for personal use. There are also two routes here that you'll want to take.
If you are the only member of the LLC, you'll be drawing it yourself from your business account.
Bear in mind that single-member LLCs are seen as disregarded entities. This means that, as far as the IRS is concerned, you and your business are pretty much the same entity when you are filing for personal tax return.
In order to make an owner's draw in this case, all you have to do is write a check that goes from your LLC into your personal account. Once tax season turns a corner, you will not have to pay separate taxes for the LLC for the amount that is transferred.
A partner in a multi-member LLC can also get through an owner's draw, and the process is pretty much the same. They write a check to transfer money from the business bank account into their personal account.
One thing to keep in mind is that, unlike single-member entities that are labeled as disregarded entity, multi-member LLCs are treated as partnerships by the IRS. As a result, they are pass-through entities.
With a pass-through entity, the income is reported to the IRS, but the partnership itself is not taxable. Instead, each partner will pay taxes themselves from the business profits.
The exact amount will be determined beforehand, when all the partners sign a partnership agreement. Reasonable compensation will be determined at that point as well, which will be delivered through Schedule K-1.
All partners need to pay income tax in full, even if they don't make an owner's draw that month. While a multi-member LLC business owner does not have to pay income tax, they will still have to pay self-employment tax.
If your LLC is taxed as a C-corporation or S-Corporation, then you will not be able to take an owner's draw from the business bank account. Instead, you'll have to hire yourself and put yourself on the company's payroll.
Indeed, by not taking an owner's draw, you will not be able to get the income tax benefits that you would normally have. You'll have to diligently pay taxes from your self-employment tax to payroll tax and other associated taxes.
With that in mind, there are still a couple of advantages to hiring yourself. When you do that, the move will lead to the generation of Form W-2. This can come in handy for the owner of an LLC who wishes to apply for a loan in their personal life (i.e., a car loan or a mortgage).
Just like any other employee, you'll have all your taxes withheld from your paycheck. This includes income tax, Social Security and Medicare, and other taxes that employees have to pay in your state.
The wage of an employee is seen as an operating expense - and therefore, you may deduct that from the company's profits. As the LLC owner, this should bring more money to your pockets.
You may also hire yourself as an independent contractor, in which case you will have to pay the self-employment tax rate. The good news is that if you pay this tax in this scenario, you will not have to deal with income tax.
Aside from the salary, an LLC owner can also choose to receive dividends from the earnings of the company. The amount that you receive will be determined in the Articles of Incorporation. Basically, dividends are amounts of money that get paid to shareholders (for example, the LLC owner).
You must keep in mind that corporations are required to pay double taxes. This means that if your LLC is a C-corporation or an S-corporation, employees will need to pay income taxes whereas the company will have to pay a corporate tax for total earnings.
As the owner of an LLC, you might think that you do not need to calculate how much you get paid - that everything extra goes into your own pocket. However, certain considerations should be made as well, depending on the method that you decide to pay yourself through.
If you are the owner of a single-member LLC, and you choose the owner's draw as the method of paying yourself, then you may draw as much money as you want. It's your profit, after all. It is like paying yourself as a sole proprietor.
Bear in mind that you'll also have taxes to take care of, so you shouldn't draw out everything from your business account. To make things easier for yourself, you might want to keep a record of the withdrawal that you make.
You can go for online transfers, or you may choose to write a standard paper check. Choose an option that allows you to withdraw your money best, as it can offer you liability protection in the event of legal actions taken against you.
If there is more than one member in your company, business owners will need to calculate a reasonable salary. The process itself is simple, and you will get your salary through a mix of dividends and paychecks.
Determining a reasonable salary is not always easy, as tax time can be quite confusing. For instance, as dividends do not bring payroll tax, you'll pay less in taxes and receive more in dividends.
No matter if you get your payment in dividends or not, the IRS still expects business owners to grab themselves a "reasonable salary." With that in mind, they gave no further instructions on what they believe a reasonable salary would be.
Ideally, you should arrange for a salary that can at least cover your yearly personal expenses. Aside from that, it's all a matter of determining what the average salary range in your domain is.
Each company and industry are different - so, do some research and find out what the average salary of someone in your position would be. Calculate the average salary, and pay the rest in dividends.
You should hire an accountant and look together with them through your bookkeeping. They will likely have better financial knowledge as compared to you, and they will also know how to deduct your taxes so that you save on your personal tax return.
With their help, you should be able to figure out how much your small business can afford to pay you, aside from covering your personal expenses.
Many LLC members may choose not to pay themselves at all - and instead, reinvest all of the LLC profits back into the main operation. This will help the company to grow, and when they decide to pay themselves once again, their personal bank account will look much better.
Bear in mind that even if you decide not to pay yourself, you'll still be required to pay income tax. After all, as the owner of the LLC, the profits will pass straight through your personal income tax return.
Taxes can be complicated, especially for a new business owner. When switching from a sole proprietorship to LLC, you'll have to pay personal taxes as well as business taxes. It will be quite easy to get them mixed up if you are not careful enough.
As a business owner, it might be tempting to use the easiest payment method. However, this tactic might have you paying even more in terms of penalties and taxes.
Here are some of the most common mistakes that an LLC owner might want to avoid:
Ideally, you might want to get a tax preparer or an accountant to make sure that all of your finances are in order. They'll know exactly what tax deductions you are entitled to and when you have to pay income tax so that you don't end up underpaying or paying too much.
Usually, a single-member LLC is taxed as a sole proprietorship, whereas a multi-member or a general partnership is taxed as a corporation. The way you pay taxes will affect exactly how much the LLC members will receive in income.
Every small business owner has questions in regard to getting their payments. Here are some answers to the most commonly-asked questions.
Yes, you can pay yourself as an employee of your LLC. Depending on the way you are taxed, you might go for a standard owner's draw, or you may put yourself on the payroll of your company.
The best way to pay yourself will depend on your purpose. For instance, if you want better benefits in regard to your income taxes, then an owner's draw might be the best option. However, if you need proof of income for a mortgage or a car loan, then putting yourself on the company's payroll might be the more sensible choice.
If you tax your LLC as a C-corporation or S-corporation, you may have better tax-saving benefits. This applies to businesses that have an active trade, with high payroll taxes.
If you do not want to appear as a "full-time" employer in your LLC, then you might want to hire yourself as an independent contractor instead. This way, the LLC would issue a 1099-MISC form after your services are completed.
Even if you are the LLC owner, you can still take a salary just like you used to. In fact, this will help you maintain a sense of financial security - like nothing has changed, routine-wise, once you got out of your desk job.
You just need to figure out which payment option works best for you, and what your average salary range should be. Bear in mind that you need to consider your company's profits, along with the taxes that you have to pay.