How to Pay Yourself through your Limited Liability Corporation (LLC)

How to Pay Yourself through your Limited Liability Corporation (LLC)

If you are thinking of opening an LLC corporation or if you own one, you can be questioning how to pay yourself through your company. The right method depends on how the IRS consider your business, it could be as Sole-Proprietor, a Partnership, or an S-Corporation.

It is important to remark that LLC Companies are considered past through entities, meaning they are not subject to double taxation as regular Corporations.

To open a company, you must file the articles of incorporation in the State you are going to operate in, and you must apply for an Employer Identification Number (EIN) with the IRS. Once The IRS provides you with the EIN you can go to any bank and open a business bank account. When your business start operating and generating income, the money is going to be deposited in your business bank account, and once you start generating profit here is when you would want to start paying yourself.

The IRS follows strict rules when it comes to how members of limited liabilities companies are remunerated and how those payments are classified and reported. When you open a single member LLC, meaning you are a sole owner, the IRS by default consider your company as a Sole-Proprietor. On the other hand, if the LLC has more than one owner, by default your company is considered a Partnership. In contrast, to enjoy the benefits of being taxed as an S-Corporation you must file Form-2553 to make the election.

At this point you know a limited liability corporation (LLC) could be treated in three different ways by the IRS, but what it has to do with the compensation of the members?

How to pay yourself if you are taxed as Sole-Proprietor

As an LLC taxed as a sole proprietor you must make what is called owner’s draws. Owner’s draw is when you transfer some of your profits from your business bank account to your personal bank account. This approach is similar as when a company pays out distributions to the owners, and there are two ways to do it. You can pay yourself one sum lump at the end of the year or take staggered payment throughout the year. If your Florida LLC is taxed as a sole proprietor, then you will not be able to pay yourself a salary in addition to receiving distributions.

But what implications does it has on your tax return?

If you are the owner of an LLC taxed as a sole-proprietorship you must file your taxes in a Schedule-C within your personal tax return. All the profits generated during the year will be considered regular income and will be taxed at a regular income tax rate. Also, you will have to pay Social Security/Medicare taxes which is typically 12.6% of the income (profit). It is recommended to pay these taxes every quarter to avoid penalties and the end of the year.

Sole-Proprietor companies are strongly recommended to startup very small companies with profits under $50,000 annually.

How to pay yourself if you are taxed as a S-Corporation

If your company is making more than $50,000 in profits yearly, you may consider file form 2553 with the IRS to make an S-Corporation election. If you limited liability company is taxed as an s-corporation then you have additional flexibility. You will be able to take distributions from your company, you will be able to pay yourself a salary or you can do a combination of both under certain conditions.

As an S-Corp shareholder who provides services to the company, you must pay yourself a reasonable salary. Determine an appropriate salary based on industry standards and the value of the services you provide. This salary is subject to regular payroll taxes, including Social Security and Medicare taxes. Some business owners use a 60/40 rule to determine their salary, with 60% of their business income coming from their salary and 40% from their distributions.

But what implications does it has on your tax return?

Determine the portion of the distribution that constitutes a dividend and the portion that is a return of capital. Dividends are taxable income, while the return of capital is generally not subject to immediate taxation. The return of capital reduces the shareholder’s basis in the S-Corp stock or capital account.

Any dividend income received from the S-Corp must be reported on the shareholder’s personal tax return. The net profit will be reported on Form K1 and issued to the shareholders. This will be taxed as part of the individual’s taxable income.

It’s important to note that while your salary is subject to self-employment taxes (Social Security & Medicare), the dividend distribution is not subject to those taxes. However, the dividend distribution may still be subject to individual income tax at your personal tax rate.

How to pay yourself if you are taxed as a Partnership

Multimember LLC companies are taxed similar as sole proprietor LLC. The key point on this type of companies is the operating agreement between partners. It is highly important that business owners of partnerships include in their operating agreement percentages of ownership and how the profits are going to be distributed based on those percentages.

Multi-member LLCs, classified as partnerships, are treated as “pass-through entities” by the IRS. This means that although business income must be officially reported to the IRS, the business itself isn’t taxed. Instead, each member’s share of the profits (as determined in the business’s LLC operating agreement) is treated as their personal income.

Like single-member LLCs, multi-member LLC members also pay themselves through the owner’s draw method. They can each draw as much or as little of their shares as they choose, as long as sufficient funds remain on hand for day-to-day business expenses and growth.

If financial reserves permit, these LLCs can set up guaranteed payments for members. Similar to salaries, guaranteed payments are paid out regardless of business performance.