How to Pay Yourself as an LLC Owner

It’s not surprising that limited liability companies (LLCs) offer one of the most popular ways to structure a business and protect oneself from personal liability. However, many entrepreneurs might know how to pay themselves and earn a living while running a business.

Understanding LLCs

An LLC is a business structure that combines the limited liability protection of a corporation with the flexibility and tax advantages of a partnership or sole proprietorship. 

In an LLC, owners are called “members” and are not liable for the obligations and circumstances of the company. For instance, if the LLC incurs debts or faces legal action, the members’ assets, such as their homes or savings accounts, are usually not at risk. 

Owners can also be taxed as a pass-through entity, where the business profits are passed through to the owners’ individual tax returns or as a corporation.

Types of LLCs

• Single-Member LLC (SMLLC): As the name suggests, an SMLLC is owned and operated by a single individual. The IRS treats SMLLCs as disregarded entities; the business’s income and expenses are reported on the owner’s personal tax return. 
• Multi-Member LLC (MMLLC): A multi-member LLC is owned by two or more individuals, each holding a membership interest in the company. Unlike SMLLCs, MMLLCs are usually treated as partnerships for tax purposes.
• Series LLC: A series LLC allows for the creation of multiple “series” or distinct divisions within a single LLC. Each series operates as a separate entity, especially for federal tax purposes that may be subject to specific IRS guidelines.

Ways to Pay Yourself from an LLC

Bear in mind that there is not just one way to pay yourself a salary in an LLC. On the contrary, there are several options available. Let’s look at some of them:

Option #1: 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.

Remember 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. You will also need to pay income taxes on your salary.

Option #2: Do an Owner’s Draw

This involves withdrawing funds directly from the business’s profits. Unlike a salary, an owner’s draw is not subject to withholding taxes or payroll taxes. Instead, the owner is responsible for reporting and paying taxes on these distributions when filing personal income tax returns.

To utilize an owner’s draw effectively, LLC owners should:

• Exercise Caution: While owner’s draws offer flexibility, excessive withdrawals can jeopardize the company’s financial stability and lead to cash flow problems.
• Plan for Taxes: Owner’s draws are not subject to payroll taxes but are considered taxable income. LLC owners should set aside funds to cover any tax liabilities associated with their draws.
• Monitor Cash Flow: Regularly reviewing the company’s cash flow can help LLC owners determine when to take an owner’s draw without adversely impacting operations.

Option #3: Receive Distributions

Another way to pay yourself in addition to earning a salary is by receiving distributions from the LLC’s profits. These distributions are based on each individual’s investment in the LLC, also called 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.

Make sure sufficient profits are retained within the business to cover operational expenses, expansion initiatives, and unforeseen contingencies. Balancing distributions with retained earnings helps sustain the LLC’s long-term viability and growth potential.

Option #4: Request Reimbursements

Those who incur business-related expenses personally can seek reimbursement from the company. This method allows you to cover travel, supplies, or professional development costs while maintaining accurate records for tax purposes.

We recommend establishing clear guidelines and documentation requirements for requesting reimbursement. This will streamline the process and maintain transparency by ensuring that the expenses are legitimate and directly related to business operations.

Moreover, reimbursements are treated as deductible expenses for the LLC, reducing the company’s taxable income. As a result, you will reduce the company’s taxable income and recoup out-of-pocket costs incurred from business activities.

Option #5: Get Equity Compensation

In some cases, you might choose to compensate yourself through stock options, membership units, or equity grants. This approach aligns the owner’s interests with the long-term success and growth of the business, as equity value is tied to the company’s performance.

Equity compensation can be attractive for startups or high-growth ventures where cash flow may be limited, but the potential for future valuation appreciation is significant.

Option #6: Make Retirement Contributions

Paying yourself through retirement contributions is a tax-efficient way to save for the future while reducing current tax liabilities. LLCs can establish retirement plans such as Simplified Employee Pension (SEP) IRAs, Solo 401(k) plans, or SIMPLE IRAs, allowing owners to contribute a portion of their income to retirement savings on a tax-deferred basis.

Contributions to retirement plans not only help LLC owners save for retirement and provide tax benefits by reducing their taxable income. Many retirement plans also offer investment options to help grow savings and provide financial security over time.

Option #7: Attain Independent Contractor Status

Some LLC members choose to work for the LLC as independent contractors, which allows individuals to get paid regularly. Being one can help owners who want to earn a salary and do not mind filing a W-9 form and paying self-employment taxes.

Final Thoughts

Paying yourself as an LLC owner requires careful consideration and planning to optimize both personal and business outcomes. By leveraging the flexibility offered by this business structure, you can choose from a range of payment options that align with your objectives while ensuring compliance with legal and tax requirements. 

Although 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.

One of the best ways to understand self-compensation is by working with an LLC formation expert. They can provide valuable advice and ensure compliance with applicable regulations.

Call 1-800-508-1729 to schedule a FREE consultation with one today!

DISCLAIMER: The above material has been prepared for informational purposes only and contains the provider’s opinions. It is not intended to provide tax, legal, or accounting advice and should not be relied on for such advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.