You are a new business owner and have decided to organize your business as a limited liability company (LLC). You are its sole owner and work for the company. How do you pay yourself? Are there guidelines regarding how often and how much you are entitled to? How do self-employment taxes come into play? The answers to these questions depend on how your LLC is taxed.
Taxed as a Disregarded Entity
By default, a single-member LLC is taxed as a disregarded entity. This means that the LLC's income is treated as personal income for tax purposes. As a result, there are fewer restrictions and more options for how you pay yourself. One option is to write yourself a check. When keeping your books, this type of payment is called a “draw” or “owner's distribution.” You can also pay yourself by transferring funds from your business account to your personal account, but this will likely raise a red flag pertaining to piercing the veil.
Single-member LLC owners are responsible for paying self-employment taxes on the LLC's profits; however, there is no automatic tax withholding. Instead, you are required to pay quarterly taxes based on the income you have generated during the quarter. How much you pay in self-employment taxes depends on your current income and tax bracket.
Taxed as an S Corporation
If, on the other hand, you elect for your business to be taxed as an S corporation, there are more considerations to keep in mind in order to take advantage of the tax-saving strategies associated with this form of taxation. First, you should pay yourself a reasonable salary. The Internal Revenue Code does not provide significant guidance pertaining to what constitutes a reasonable salary, but the following factors are often relevant to the determination.
- What do other similarly situated professionals get paid?
- How much experience do you have?
- How often are distributions or bonuses issued?
These questions are aimed at examining the reasonableness of the salary based on common industry practices as well as your unique situation.
The salary you pay yourself is subject to standard Federal Insurance Contributions Act (FICA) tax withholding (for Social Security and Medicare) as in typical employment arrangements. Additionally, it differs from the draw or owner's distribution discussed above for disregarded entities because the amount that you pay yourself as an employee beyond a reasonable salary is not subject to self-employment tax.
As the owner of a single-member LLC taxed as an S corporation, you are entitled to any of the profits after expenses have been paid. Any amount paid to you as an owner above your salary can be categorized as a dividend or bonus. This is one of the most attractive features of an LLC with an S corporation tax election. These opportunities for tax withholding can provide the sole member of an LLC significant tax savings.
We Can Help
Regardless of your single-member LLC's taxation election, it is important to follow a clear system for paying yourself and keep accurate records. If you need assistance understanding the unique characteristics of your LLC and what you are required to do as a single-member LLC, do not hesitate to call our office. Our team of experienced attorneys can help you understand your options so that you choose the best method for your business.