Do you want limited liability protection of a corporation, avoiding its technicalities? Or maybe you are looking for a structure, which allows you to enjoy the benefits of “pass-through” taxation? The answer to all these questions goes to a limited liability company.
An LLC means a legal entity established under state legislation to carry out commercial activities in its own right, distinct from the names of its members. It combines the characteristics of some other business units, such as a corporation and a sole proprietorship, and therefore offers the owners quite appealing terms. Although an LLC is obliged to go through a formal start-up procedure by filing documents with the state and paying fees, the process is clear and easy. You don’t have to fill out tons of paperwork or comply with any requirements for the internal organization of the venture. Furthermore, there is no limitation on the number of owners who are usually referred to as participants.
To wrap it up, an LLC gives you a variety of opportunities to customize your business. You can change its structure, taxation, name, and more. That’s why novice entrepreneurs often prefer this alternative.
How To Pay Myself If I Own an LLC?
One of the fundamental principles of an LLC involves the separation of personal and corporate funds. Even if you own the firm and work for it, ensuring that daily tasks are handled, you still can’t just take as much as you want from the corporate vault. Payroll to the owner should be done in the manner required by law. This way, you avoid legal and tax implications.
So, how do you pay yourself? To answer this question, you first need to determine whether your organization is taxable as a partnership, a sole proprietorship, or a corporation.
Single-Member LLCs: Owner’s Draw
If your venture is taxed as a sole proprietorship, from the IRS perspective, the owner’s earnings are indivisible from the company’s revenues. Typically, the owners of sole proprietorships do not receive traditional wages. Instead, when you need funds, you can take an owner’s draw.
The owner’s draw procedure is very simple. All you have to do is write yourself a check or transfer money directly from the firm’s checking account to your personal one. The use of specialized accounting software is also allowed. However, paying in cash is not recommended. This makes it difficult to keep the company’s bookkeeping, which, in turn, could attract the attention of the IRS.
When you receive an owner’s draw, you do not have to withhold payroll tax, but you should pay income tax. The minimum and maximum amount of an owner’s draw, as well as its frequency, are not specified by law, so it is up to the owner’s discretion.
Multi-Member LLCs: Owner’s Draws and Guaranteed Payments
The tax regime for a multi-member company is pretty much the same as for a partnership. In other words, the IRS treats the profits of the enterprise as the personal income of its owners. This exempts it from the need to file corporate returns, but participants are to enter earnings and losses of an organization on their personal returns. The share of profit, which each owner can claim is usually stated in the formation documents. To inform the participants and the IRS how much tax to expect, the entity files Form 1065.
The requirements for payments of multi-member LLCs are the same as those for single-member ventures. Funds are disbursed according to a check or transfer made during the owner’s draw process.
Finances are a vital resource for developing a business, so when planning the owner’s draw, keep in mind that there should be enough money left on the company’s account. Naturally, this can affect the number and frequency of payments. Nonetheless, if your organization has already begun to consistently generate substantial income, you can take advantage of guaranteed payments. That way, an LLC will regularly send predetermined amounts to participants, no matter how much profit or loss it makes.
Remember, whether you take your share of the profits or reinvest them in the firm, you are to pay income tax and self-employment tax.
Corporate LLCs: Salary and Distributions
If you are interested in switching to C-corporation or S-corporation status, then apply to the IRS. Companies with such designation may not take owner’s draws. Instead, you can officially become an employee of an LLC and receive a fixed salary in addition to a percentage of profits in the form of dividends.
Payroll tax and income tax will be automatically deducted from your earnings. And dividends are not taxed.
How Much To Pay Yourself From Your LLC?
The IRS says that the owners are entitled to reasonable compensation. However, how to calculate this sum? Actually, you just need to consider the following points:
- Determine the approximate amount of your annual expenses. This category should include daily expenses, as well as possible loan payments, pension, and insurance deductions;
- Estimate how much money the firm needs for trouble-free functioning and stable development. Take into account current expenses, as well as taxes or mandatory payments the company should make. Do not forget about reserve funds. You probably need to provide funds for the purchase of new equipment or a “financial cushion” in case of unusual situations;
- Consider how much your LLC can pay you, given that the company’s balance sheet should not go into deficit. If possible, consult with an accountant for a more accurate estimate since correct budgeting is important. It stands as one of the keys to successful business growth;
- Analyze the income statistics of other employees to find out the average wage for your position in the chosen field. Paying too little or too much may not only affect your venture but also expose you to liability.
The ratio of earnings to dividends you receive directly affects the amount of taxes you have to pay. The higher your wages and the lower the dividends, the higher your taxes will be.
What Is the Best Way to Pay Yourself From an LLC?
Undoubtedly, maintaining the stable functioning of the venture requires time and effort. Such work should be rewarded! Nevertheless, how to properly pay yourself without catching the attention of the state or the IRS?
The first thing to bear in mind is that company finances are its property, so the owner can only receive them in the legally prescribed manner. If you pay yourself out of LLC money, write a check or transfer from the corporate account to your personal one. This will make a good defense if the state or a court has any questions about the firm’s finances.
If you are the owner of a single-member organization, use the owner’s draw to distribute the payments. You can set the frequency and amount of your earnings yourself, but note that you should leave a certain sum on the company’s balance sheet to keep it running.
As for multi-member LLCs using “pass-through” taxation, which is set by default, there are a bit more options for participants. Instead of the owner’s draw, you can set guaranteed payments, the amount and frequency of which do not depend on the profits and losses of the organization.
After all, the active LLC owners who have chosen corporate taxation are its employees. Besides dividends, which are a percentage of earnings set by corporate documents, they are entitled to get paid. However, it has to be reasonable to avoid IRS audits.