How Do LLC Members Pay Themselves: Everything You Need to Know
If you're planning on becoming involved with an LLC, you may be wondering: how do LLC members pay themselves? 3 min read
How to Pay Yourself in an LLC
If you're planning on becoming involved with an LLC, you may be wondering: how do LLC members pay themselves? You have two options when it comes to paying yourself:
- You can take wages as an employee
- You can pay yourself profits as an LLC member
Members can also access and pull periodic draws.
Employee Wages for LLCs
In terms of the first option, as long as you are actively involved you are eligible for wage payments as an employee of your LLC. For example, if you are in charge of marketing and managing all client relationships, you have an active role in the company. Since you are fulfilling a key role, you can set yourself up as an employee. There is also the option of compensation as an independent contractor. However, this structure does not make sense for most companies.
Profit Distribution for LLCs
As an LLC member, you also have the option to receive year-end profit distributions. Since each member will have a percentage interest, also known as the member's capital account, they will be eligible for their portion of the profits. For tax purposes, these profits generally pass through to the LLC members. For example, if you own 20 percent of the company, you are entitled to 20 percent of the profits.
If you do not want to receive wages as an employee but would still like to receive periodic payments throughout the year, you can generally do so as long as it is viable. When you do take a draw, which will be an advance payment on the expected year-end profits, your capital account decreases. If you take this approach, your capital account will go back up at the end of the year once all of the LLC's profits are accounted for.
Forms Used By LLCs for Payment
As an LLC, you must file the right tax forms. This is why you are highly encouraged to keep accurate, organized records throughout the year.
- Members who will be paid as an employee must file Form W-4. The LLC itself will pay these employee-members as a W-2 employee.
- If you are paying yourself as an independent contractor, you will need to file Form W-9 with the LLC. Then the LLC need to file Form 1099-MISC with the IRS.
- If you are taking draws, you need to keep track of each payment in terms of your capital account. Since this can become fairly complicated, sometimes it is best to seek the assistance of a professional accountant.
Taxes for LLCs
Understanding taxation in terms of your business structure is imperative before you begin operating as an LLC. When you know what will be expected of you at the end of the year, you can ensure all LLC records are organized and accounted for.
- When you pay yourself as an employee, the LLC must withhold both employment and income taxes from each payment.
- If you are receiving payment as an independent contractor, the above taxes do not need to be withheld. Instead, you will pay these taxes on all payments received when you file your individual tax return.
Reasonable Compensation/Wages Explained
When it comes to taking a salary, the IRS requires that the owner make a reasonable amount for the work they do. As a guideline, it is recommended that you pay yourself an amount similar to what another business would pay someone who does what you do within the company.
It is important you're aware of what the IRS expects in relation to payroll taxes. S-Corp owners have come under scrutiny the past few years because they often take draws instead of a salary. This helps them avoid payroll taxes, which can come at an unexpected cost. One of the largest financial risks associated with this approach is incorrect payroll tax reporting. This can result in significant interest and associated penalties.
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