Some people may think that being the owner of a Limited Liability Company (LLC) means you can pay yourself whatever you want. A million dollars per year sound good? Perfect, it’s automatically entered into your bank account! Of course that sounds incredible…but unfortunately, it is not reality.
Paying yourself as an owner of an LLC can be complicated, and there are tax consequences that come along with it. Keep in mind that you can only pay yourself an income based on the success of the business. You will not be able to pay yourself $10,000 a month if your business is only bringing in $5,000 each month in revenue. Plus, you have to consider the salary or hourly rates of other workers you may employ, as well as bills you must pay to keep the lights on.
You would be in a massive amount of debt if you were greedy and not flexible with your own income in this situation. As a business owner, your income may often be fluid — you could see some profitable months followed other months that aren’t as profitable. That is unfortunately part of owning and operating a business.
Your Employee Classification and Payment Types
There are several ways you can classify yourself as an employee, and different tax specifications for each. Here are some of them:
Corporate Officer and Owner
An officer of a corporation is typically an employee who performs no services (or only minor services). This type of officer is not entitled to receive any pay. On the other hand, a corporate owner who conducts work in the business can receive a salary and will have to pay employment taxes.
A partner may go in on the business with one or more people, but they are considered more of an owner than an employee. The IRS details the following:
“A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it ‘passes through’ any profits or losses to its partners. Each partner includes his or her share of the partnership’s income or loss on his or her tax return. Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions.”
Single-member LLC or Sole Proprietor
A single-member LLC or sole proprietor can draw funds out of their business at any time, meaning that they receive their “salary” directly out of the profits of the business. If you’re a sole proprietor or single-member owner, you’re not considered an employee who takes income in the form of a regular paycheck.
This also means no Social Security, Medicare, federal or state income taxes are directly withheld from your income. (Instead, you’ll have to pay an estimate of these manually to the IRS each quarter.) Your income comes from the profits of the business itself. If you are part of a multi-member LLC, it works a bit differently since you are taking a distribution of the business’ profits and sharing it between workers.
How Much Should You Pay Yourself?
This is the million-dollar question! Paying yourself can be tricky — as mentioned earlier, you can only draw from or distribute the profit the business makes. If the business isn’t making a profit, that may mean no income for you at that time.
Once you figure out what type of “employee” you are and what payment and tax specifications you need to follow, you can take a look at your LLC and make a reasonable judgment on how much you could potentially make.
Still unsure where you fall and how much you should pay yourself? The IRS has established guidelines for determining a reasonable salary based on several factors, including the following:
- Duties and responsibilities
- Time spent
- Comparable amounts paid to others doing similar work
Keep in mind that if you are a sole proprietor, partner, or LLC member, you will need to pay self-employment taxes when you file your personal tax return for the year. Self-employment taxes are paid to the IRS along with federal income taxes. You will definitely want to factor this into your income to get a better understanding of the net profit available to pay your “salary.”
If you need assistance, Incfile can help you manage your business and file your business taxes, as well as break down the different business entities and employee classifications you can choose for yourself.