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Exactly How To Pay Yourself From Your LLC

How To Pay Yourself From An LLCHow To Pay Yourself From An LLC
min read
August 21, 2023

For business owners and start-ups, creating a Limited Liability Corporation (LLC) protects you from personal liability and provides specific tax benefits. LLCs provide flexibility for management and ownership, but this also means figuring out how to pay yourself isn’t always straightforward.

There are a couple of main ways to pay yourself through your LLC. You can treat yourself as an employee or wage-earner or choose to benefit from the profits as the owner of your own business. Each method has its pros, cons, and tax implications at the end of the year.

Keep reading to find out:

What Is an LLC?

Limited liability companies blend the characteristics of a corporation with those of a partnership or a sole proprietorship, limiting an owner’s personal legal liabilities for business activities.

The rules for LLCs depend upon each state. However, LLC owners are typically referred to as LLC members. Individuals, corporations, and other LLCs can all qualify as members of an LLC.

Compared to corporations, LLCs are easier to create and allow for more tax flexibility. For example, LLCs can choose to pay taxes as a corporation, or each member can list the company’s profits and losses on their personal tax returns.

When comparing LLCs to Sole Proprietorships, the critical difference is that a Sole Proprietorship can only have one owner and does not provide liability protection.

What Are The Different Types of LLCs?

There are several types of LLCs, and each classification has different rules and tax implications. The most popular LLC is the Single-Member LLC (also known as a Sole Proprietor LLC). 

Note that a Single-Member LLC is different from a Sole Proprietorship. Technically, you don’t need to incorporate to operate a Sole Proprietorship but a failure to incorporate also means that your personal assets are liable if your Sole Proprietorship is sued in the course of doing business.

A Single-Member LLC has one owner who is responsible for company transactions, taxes, and business debts. This is the cheapest and easiest LLC to form. 

However, multiple members can form an LLC. Structures like that include General Partnerships, Family Limited Partnerships, and Member-Managed LLCs. 

Multi-Member LLC business entity structures spread the responsibility for taxes and debts between multiple partners. In some cases, such as the Limited Partnership, one person retains total liability. 

General Partnerships are the preferred structure for many small and medium-sized businesses. A General Partnership is essentially an LLC business agreement between two people.

Traditionally, single-member LLCs are taxed as sole proprietors, and multi-member LLCs can be taxed as partnerships or corporations.

Your taxes will affect how each member of your LLC is paid.

How To Pay Yourself Through An LLC

As a small business owner, there are two ways that you can pay yourself: you can choose to take an owner’s draw or pay yourself a salary. 

The method you choose will affect your business and personal taxes. 

Taking An Owner’s Draw

When a business owner takes money out of the business for personal use, this is referred to as an owner’s draw (or just, a draw.) 

If you are a single-member LLC, you will pay yourself through an owner’s draw.

As a single-member LLC, you qualify as a disregarded entity, which means that the IRS views you and your company as one in the same. In other words, the taxes from your company are passed directly through to you and are reported on your individual tax return. 

To pay yourself, you can simply write a check from your LLC to your personal account.  When tax time comes around, you won’t have to file separate taxes for your LLC. 

Taking An Owner’s Draw From A Multi-Member LLC

Single-member LLCs are not the only type of small businesses with owners who choose to forego a salary and pay themselves through an owner’s draw. 

As mentioned before, the IRS treats multi-member LLCs as Partnerships by default. Like disregarded entities, Partnerships are pass-through entities. 

Pass-through entities report income to the IRS, but the partnership is not taxed. Instead, each partner pays part of the taxes on the company’s total revenue. The portion of taxes each partner pays is determined beforehand when the partnership agreement is written.

Each partner receives their share of the company’s earnings on the IRS Schedule K-1 form. It’s important to note that partners must pay full income tax on their share of the profits even if they don’t draw on the earnings. 

When a partner draws money from the company, they are not subject to income tax again. However, they are subject to the self-employment tax.

How To Pay Yourself As An Employee

If you choose to have your LLC taxed as a corporation, you cannot take an owner’s draw. Instead, you will have to hire yourself as an employee of the corporation and put yourself on the company payroll.

Not taking an owner’s draw means not benefitting from favorable taxation when it comes to dividend payouts. That said, hiring yourself as an employee (versus contractor) of the corporation can still be a smart entrepreneurial move. Doing this will generate a W-2 form that can come in handy when applying for loans in your personal life (mortgage, car financing, etc.).

Like any other wage-earner, you should have your income tax, social security, and Medicare automatically withheld from your paychecks. You can choose to pay yourself as a salaried employee and file a W-2 tax form. 

When it comes to taxes, employee wages are considered an operating expense; thus, they are deducted from the company’s profits.

Alternatively, you can hire yourself as an independent contractor and file an IRS W-9 form with your LLC. Your LLC will also have to file IRS form 1099-NEC, and you will pay self-employment taxes as an independent contractor, instead of income tax. If you have a skill that adds value to your business, you can pay yourself as a contractor rather than hiring a third-party vendor. By hiring yourself, you can keep expenses predictable and within budget.

Choosing whether to pay yourself as an employee or a contractor comes down to the IRS Common Law Rules, specifically the third rule that deals with the type of working relationship.

If you regularly perform work that is essential to the business, then you should pay yourself as an employee. However, if your skills are more specialized and only required on a project basis, you can save money by hiring yourself as a contractor.

Third-party contractors often markup their services to make money. And, if your contractor charges an hourly rate (not a per-project rate) it’s hard to accurately forecast the final cost. 

When you hire yourself, you can avoid paying any upcharges and ensure your project stays under budget.

Receiving Dividends

On top of your salary, you can also choose to receive dividends from the company’s earnings. The dividend amount is established in the Articles of Incorporation. Dividends are a sum of money that a company pays to shareholders (like an owner).

It’s important to know that corporations are subject to double taxes. This means the corporation pays taxes on its total earnings, and each employee pays individual income taxes on their salary.

One crucial difference with dividends is that they are not subject to payroll tax. So, if you pay more of your income through dividends, you will pay less in taxes. 

However, keep in mind that the IRS requires you to pay yourself a “reasonable compensation” for your role.

Paying Salaries From A Multi-Member LLC

As a multi-member LLC, the process of paying members as salaried employees is similar. If all members contribute to the operation of the company, then all members must be paid a salary. 

However, if only one member manages the business and others are passive partners, like investors, then only the manager needs to be paid a salary.

How Much To Pay Yourself

Owner’s Draw

As a business owner, you can take money out of the business whenever you like. However, if you want to keep your taxes in order, you need to record your withdrawals. 

You can choose to write paper checks or make an online transfer. If you fail to keep good records of your personal withdrawals from the business, you may lose your liability protection in the face of legal action.

As long as you keep a record, you shouldn’t face any issues.

Calculating A Reasonable Salary

For LLC members classified as employees, the process for how to pay yourself is quite simple. You’ll receive your income as a combination of your paycheck and your dividends. However, it’s not always easy to figure out the right salary. 

Since dividends are not subject to the payroll tax, the more you receive as dividends, the less you’ll pay in taxes. 

Whether you pay yourself in dividends or not, the IRS still expects you to pay yourself a “reasonable” salary. Unfortunately, there’s no detailed explanation of what the IRS considers reasonable.

Ideally, your salary should at least cover your annual personal expenses. Beyond that, it’s a matter of determining the typical wage for your role.

Your best bet is to do some industry research to find out the average salary range for your position in your industry. Use a tool like Glassdoor to determine your salary, then pay out the rest of your desired income as dividends. 

You can and should consult your bookkeeper or accountant to help you find the right balance between salary and dividends. 

Choosing Not To Pay Yourself

If you want all of the profits to go toward the business, you can choose not to pay yourself. In other words, you’re reinvesting the business earnings back into its operations. 

Note that in this case, you will still pay income taxes on the profits since these are passed through to your personal income tax return.

Avoiding Tax Mistakes

Let’s face it; Taxes are complicated. And when you are filing business taxes and personal taxes, it’s easy to get mixed up. 

While it might be tempting to use the easiest payment methods, you might end up paying more in back taxes and penalties. 

Here are some common mistakes to look out for: 

Your best bet is to work with an accountant to keep your income and your taxes in order. What’s more, a professional can keep you aware of all of the tax deductions and benefits available to you as a business owner. Using a payroll platform like Hourly in tandem with hiring a professional to help with accounting will help to ensure tax compliance.

Final Thoughts: How To Pay Yourself From Your LLC

With protection from personal liability, it’s easy to see why LLCs are a common choice for small and medium business owners. Filing as an LLC provides several benefits and is generally much more straightforward than filing as a Corporation as far as your taxes are concerned. 

When setting up your LLC, you want to figure out which structure is the best for your business. To do so, you should first understand your role in the company and how to pay yourself.

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