LLCs are a popular way to structure your business and protect yourself from personal liability. But many entrepreneurs are confused about how to pay themselves and earn a living, while also running a business.
It is important for business owners to understand that there is not just one way to pay yourself. There are actually several options. Let’s take a look:
Earn a salary as an employee: Business owners actively working in an organization with specific responsibilities can earn a consistent income via a salary. This salary comes from the LLC’s operating expenses and is deducted from the profits.
Keep in mind that this salary, as well as any bonuses, can’t be extravagant—and must meet industry norms—as the IRS will only allow “reasonable” wages to be deducted. The IRS guidelines for determining a reasonable salary suggest basing the amount on an individual’s duties, responsibilities, experience, time and comparable salaries to others.
Your LLC should consider you a W-2 employee and withhold income and employment taxes. At the same time, you will need to pay income taxes on your salary
Receive distributions: Another way to pay yourself in addition to earning a salary is receiving distributions from the LLC’s profits. These distributions are based on each individual’s investment in the LLC, also referred to as an LLC capital account.
Because some LLC members would rather not wait for year-end profit distributions, they can choose to establish ongoing monthly payments. These payments are considered a draw against the LLC’s year-end profit.
Independent contractor status: Some LLC members choose to work for the LLC under the status of an independent contractor, which allows individuals to work for the LLC and get paid on a regular basis. This can be a good option for individuals who want to earn a salary and do not mind filing a W-9 form and paying self-employment taxes.
While some individuals opt to receive compensation and a regular income, others choose not to pay themselves and keep the profits in the LLC. There is no right or wrong answer. It depends solely on your unique needs and what is best for the LLC as a whole.