Key Takeaways

  • LLC members cannot generally receive a salary unless the LLC elects to be taxed as a corporation.
  • LLC members are typically paid through owner's draws, profit distributions, or guaranteed payments.
  • If the LLC elects S corp or C corp taxation, members performing substantial services must be paid a reasonable salary.
  • LLCs must avoid disguising distributions as salaries to prevent IRS penalties.
  • Owners may choose to reinvest profits, take loans from the LLC, or work as independent contractors, each with unique tax implications.

There are certain LLC salary requirements that you should be aware of when you first form your business. This is because there are different ways that LLC owners can pay themselves, depending on how the business is taxed and structured. Knowing how to properly distribute your LLC's income will determine the long-term success of your business. 

LLC Salary: Overview

Being the newest addition to the types of businesses you can form, an LLC, or "limited liability company," is a desirable entity to both form and operate. Owners are referred to as members and enjoy limited liability protection. There is no limit to the number of members, and single-member LLCs are possible. 

By forming this type of business, the owners benefit from plenty of flexibility. Based on this level of flexibility, LLCs are incredibly popular. However, one question is commonly asked, "As an owner, can I pay myself a salary?" 

The answer to this question is that it depends on how your LLC is taxed. 

For example, will your LLC be taxed as a partnership, C corporation, or S corporation? If you elect to be taxed as an S corporation, you will continue to operate as an LLC but will adopt a new approach in regards to taxation. 

Can LLC Members Take a Salary?

Under the federal tax code, if you form an LLC with more than one member, you will be taxed as a partnership by default. This means that if you are operating a single-member LLC, you will be taxed as a sole proprietorship. 

In this case, all of the LLC's income is taxed and reported on each member's personal tax return. So paying salaries to members would essentially just shift income without adding any significant benefits. 

In most states, LLC members are seen as investors, rather than employees. Although a member may actively engage in managerial activities, this classification does not generally change. Unless a member meets specific employee requirements, any salary payments will be considered a profit distribution. 

When Can an LLC Member Receive a Salary?

Whether a member of an LLC can receive a salary depends primarily on the business’s federal tax election. By default, LLCs are taxed as sole proprietorships (single-member) or partnerships (multi-member), which do not permit salary payments to members. However, if an LLC elects to be taxed as a C corporation or an S corporation, then members who actively work in the business can be paid a salary just like regular employees.

To comply with IRS requirements, the salary must be reasonable compensation for the services provided, based on industry standards and location. Failing to meet this requirement may result in reclassification of distributions as wages, triggering back payroll taxes and penalties.

This scenario is particularly relevant for S corp elections, where part of the income is treated as wages (subject to employment taxes), and part may be taken as distributions (not subject to self-employment tax). Thus, electing corporate tax treatment is the primary route through which a member of an LLC can receive a salary.

Member Management

As an LLC owner, you will typically have the right to participate in the management of your company. However, in certain situations, a member can be classified as an employee. This will require other members to delegate select management tasks to that specific member.

For example, say that you partially own a 30-member LLC. If two members are given specific duties and oversee daily operations, something which the other members don't do, these two members could receive a salary. There are stipulations, so make sure you understand the requirements associated with paying members a salary. 

Profit Distributions 

When an owner invests in an LLC, they expect a return on their investment. This is typically through membership interest and the distribution of company profits. It is important to note that LLC members cannot demand that profits be distributed. However, if the LLC does distribute profits to some members, those who did not receive payment can make a legal claim as a creditor. 

Also, unlike employees, even if members do not receive a distribution, that income will be subject to personal income tax. After all, an LLC is a 'pass-through' entity. 

Owner’s Draw vs. Salary: Key Differences

An owner’s draw is the most common method for LLC members to pay themselves in default tax structures. It involves withdrawing funds from the business’s capital account rather than earning regular wages. Here's how a draw compares to a salary:

  • Tax Treatment: Owner’s draws are not subject to payroll taxes, but members must pay income and self-employment taxes on their share of profits. Salaries, on the other hand, are subject to FICA taxes (Social Security and Medicare) and require payroll reporting.
  • Documentation: Draws are less formal and can be made periodically. Salaries must be documented with pay stubs and reported on Form W-2.
  • Flexibility: Draws offer greater cash flow flexibility but may lead to underpayment of taxes if not planned properly. Salaries provide consistent income and may reduce audit risk for S corp owners.

Guaranteed Payments 

The IRS does acknowledge services provided in the capacity of a partner. However, if a partner provides services that are outside of their capacity as a partner, they will receive guaranteed payments. 

In this case, the partnership deducts these payments from the company's income. In turn, this reduces the amount distributed to each individual member. The partner then reports these payments as standard income. This means that the individual member will need to pay self-employment taxes on guaranteed payments, while the LLC will save on FICA taxes. 

Understanding how to distribute company profits can be rather complex, especially when there are multiple members involved. Depending on the role of each member, it may be ideal for you to process payments in varying ways. Once again, this will all depend on how your LLC is set-up in terms of taxation. If you are unsure about your current financial duties, speak with a professional asap. This will save you a mountain of headaches in the future — especially during tax season. 

Alternatives to Salaries and Draws

Aside from traditional compensation methods, LLC members can access funds or be compensated in these alternative ways:

  • Reinvesting Profits: Members may leave profits in the business for reinvestment. However, they must still report and pay tax on their share of the profits, regardless of actual withdrawal.
  • Loans from the LLC: Members can borrow from the LLC, but the loan must be documented and include interest. Failure to follow formalities could lead to the IRS recharacterizing the loan as a taxable distribution.
  • Independent Contractor Role: In some cases, an LLC member can be hired independently to provide specific services (e.g., graphic design or consulting). This requires a formal contractor agreement and IRS Form 1099-MISC, and does not affect their membership status.
  • Combination Approach: Particularly under S corp taxation, members can combine a reasonable salary with profit distributions to optimize their tax liabilities.

Frequently Asked Questions

  1. Can a member of an LLC receive a salary?
    Only if the LLC elects to be taxed as an S corp or C corp. In that case, members performing services must receive a reasonable salary.
  2. What is the difference between an owner’s draw and a salary?
    An owner’s draw is a non-payroll withdrawal from profits, while a salary is regular employee compensation subject to payroll taxes and formal reporting.
  3. How do guaranteed payments work in an LLC?
    Guaranteed payments are fixed compensation to members for services or capital, deductible by the LLC, and subject to self-employment tax.
  4. Can I work as an independent contractor for my own LLC?
    Yes, you can contract with your LLC for distinct services, but the arrangement must be properly documented and reported via IRS Form 1099-MISC.
  5. Do I pay taxes on LLC profits I don’t withdraw?
    Yes, with pass-through taxation, you’re taxed on your share of profits whether or not they are actually distributed to you.

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