Key Takeaways

  • LLC Owners as Employees: LLC members generally cannot be considered employees unless the LLC elects to be taxed as a corporation (C or S corp).
  • Payment Options for LLC Members: Owners can pay themselves through distributions, guaranteed payments, or as salaried employees, depending on the LLC's tax classification.
  • Tax Implications: Self-employment taxes are applicable for sole proprietors and partners, while salaries from LLCs taxed as corporations are subject to payroll taxes.
  • Reasonable Compensation Requirement: LLC owners drawing salaries must ensure the amount is reasonable to avoid IRS scrutiny.
  • Multiple Roles: Members can also work as independent contractors for their LLCs, hire family members, or take loans from the business if documented properly.

"Can you be an employee of your own LLC?" is an important question that many business owners may ask themselves if they wish to seek compensation for their day-to-day operations of the business. The ability to be an employee of your own business depends on a lot of factors including the type of business.

Partnership or Sole Proprietorship

When your business is classified as a partnership or a sole proprietorship you are allowed to be an employee on the payroll. You are allowed to pay yourself from the business income, though it will not be tax-deductible income. While there are multiple ways to pay yourself in a partnership, the easiest way is to take a distribution and make estimated tax payments throughout the year.

In both these business entities, you will pay your self-employment tax on the total amount of the business profit for the year which averages out to about 15 percent of the net profit. This makes it essential to make estimated tax payments throughout the year to avoid a huge tax bill at the end. While taking regular payment for yourself is not necessary it can keep you more organized than taking varying amounts out when you need it.

Corporations

In a corporation, the way you pay yourself will depend on the type of corporation your business is. If you are a part owner of a C corporation, you will be considered a W-2 wage earner as an officer of the corporation and be subject to taxes based on what you make for the year. If you have an S corporation, you have the ability to pay yourself through a tax-free distribution, but you will need to take a reasonable salary which you will be required to pay taxes on.

Limited Liability Company

Since an LLC is run by state laws and not federal laws, your S corporation will default to a status of a sole proprietorship if there is one owner or a partnership if there are multiple owners for taxes purposes. You do have the option to opt for your LLC to receive the S corporation tax designation to take advantage of the more beneficial taxes as long as it meets the minimum requirements.

LLC Members as Employees: IRS and Legal Guidelines

In most cases, LLC members (owners) are not considered employees. Instead, they are classified as self-employed individuals for tax purposes. This classification means they are subject to self-employment taxes, covering both Social Security and Medicare contributions. However, an LLC can elect to be taxed as a corporation, allowing members to take on the role of employees and receive a W-2 salary.

For LLCs taxed as S or C corporations, members can draw a reasonable salary for their work. A "reasonable" salary aligns with industry standards for the same type of work. If the IRS determines the compensation is too low or improperly classified, it may reclassify distributions as wages, leading to penalties and additional tax liabilities.

How to Take Pay?

When you have an LLC, you can simply pay yourself by taking money out of the business account. To keep a record of the transaction, accountants recommend that you write a check from the company account to your personal bank account. This will help keep business and personal expenses separate. It is important to remember that even if you don't take profits out of your company, you still will be required to pay personal tax on it.

Comparing Payment Methods for LLC Members

LLC members have several options for compensating themselves:

  • Owner's Draw: This method allows members to withdraw profits directly from the LLC. It's a straightforward option for LLCs classified as sole proprietorships or partnerships. However, taxes are not withheld, and members are responsible for paying estimated taxes throughout the year.
  • Guaranteed Payments: A fixed payment made to LLC members regardless of profit levels. These are treated as business expenses and reduce the LLC's taxable income.
  • Salaried Compensation: For LLCs taxed as corporations, members can receive a W-2 salary. This approach simplifies tax compliance but requires adhering to payroll tax regulations.
  • Independent Contractor Arrangements: Members can contract with their LLCs for specific services. This approach requires issuing a 1099-MISC and may limit benefits.

Each method has unique tax implications, and members should consult a tax professional or attorney to determine the best option.

Salary versus Draw

When distributing profits from your LLC, it is often referred to as a draw which is a drastic difference form an hourly or salaried wage. When you are paid hourly or through a salary, your federal and state taxes are withheld and both your portion and the employer's portion of the Social Security and Medicare contribution before you receive your pay. Conversely, when you make a draw, no taxes will be removed, and you will be required to pay both the employee and employer portion of the FICA and both federal and state estimated taxes.

Key Considerations for LLC Tax Designations

The LLC's tax classification significantly impacts how owners can pay themselves. For single-member LLCs (defaulted as sole proprietorships), members report profits and losses on their personal tax returns. Multi-member LLCs, treated as partnerships, allocate profits according to ownership percentages.

Electing S corporation status can offer tax advantages by allowing members to divide income between salaries and distributions. While salaries are subject to payroll taxes, distributions are not. This strategy can reduce overall tax liability but requires careful record-keeping to withstand IRS scrutiny.

C corporations allow members to be employees, receiving regular wages and benefits. However, C corporations face double taxation, where both corporate profits and individual wages are taxed.

Married Couples

It can get a little more difficult to pay yourself as an employee when you are married and filing a joint return. Sometimes it is best to employ your spouse and pay them as an employee as well. This will not only give you the same income when filing a return, but their salary will be able to be deducted from the profit of the business before tax is withheld. Though if this is the route you choose you will need to make sure to obtain both unemployment insurance and workers comp for them. You should always discuss this type of plan with an attorney to make sure it can stand up to IRS scrutiny.

Consider Incorporating

Sometimes the best way to take employee pay to avoid paying a high amount of taxes is to incorporate your business. This will allow you to take a salary that is considered reasonable and also give you the option of taking fringe benefits.

FAQ Section

  1. Can you be an employee of your own LLC?
    • Generally, no. LLC members are considered self-employed unless the LLC elects to be taxed as a corporation.
  2. What are the payment options for LLC owners?
    • Owners can use methods like owner's draws, guaranteed payments, salaries, or independent contractor arrangements.
  3. What is a reasonable salary for an LLC owner?
    • A reasonable salary reflects what someone performing similar duties in the same industry and region would earn.
  4. Do LLC members have to pay self-employment taxes?
    • Yes, unless the LLC is taxed as a corporation, in which case salaries are subject to payroll taxes instead.
  5. Can an LLC owner take a loan from their business?
    • Yes, but the loan must be documented in the operating agreement and repaid with interest.

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