Limited liability companies (LLCs) are the most flexible business structure for tax purposes. While that versatility can be advantageous, it can also complicate figuring out the right way to take money out of your business.
If you’re the sole business owner of a limited liability company, here’s what you should know on how to pay yourself with a single-member LLC. We’ll cover each option, when they’re appropriate, and the tax implications of the most common approach.
Can a Single-Member LLC Pay Themselves?
You can pay yourself from a single-member LLC in multiple ways, but there’s a required method for each situation. It primarily depends on how you elect to treat your small business for tax purposes. You have three options:
- Default: If you file no additional paperwork, your single-member LLC is taxable as a sole proprietorship. That means you must pay yourself exclusively through the owner’s draws.
- S Corporation: If you file Form 2553 with the Internal Revenue Service (IRS), they’ll treat your LLC as an S corp for tax purposes. You must pay yourself a reasonable salary, but you can also take any remaining profits as distributions.
- C Corporation: If you file Form 8832 with the IRS, they’ll treat your LLC as a C corp for tax purposes. You must pay yourself a salary that equals reasonable compensation if you’re involved in the day-to-day operations. However, you can also pay yourself whatever business profit is left over by issuing dividends.
Whichever taxation method you choose, you’ll always be able to pay yourself from your single-member LLC. However, the methods you use to transfer the funds differ, as will their tax consequences at the personal and business levels.
This article focuses on paying yourself from a single-member LLC the default way. Once again, in that case, you’re a sole proprietor for tax purposes and must pay yourself with LLC owner’s draws. You can’t take a salary, distribution, or dividend.
How Do I Pay Myself From My LLC?
Assuming your single-member LLC receives the default tax treatment from the IRS, you’ll need to pay yourself with the owner’s draws. That sounds formal, but there’s no official way to do this. It just means taking money out of your business to pay yourself.
In practice, business owners can complete an owner’s draw in any of the following ways:
- Writing yourself a check from your business account
- Withdrawing the funds in cash from your business bank account
- Electronically transferring funds from your business to your personal account
Ultimately, it doesn’t matter which method you use to transfer your LLC profits to yourself. It’s simply a matter of convenience. The tax consequences are identical, and the transactions show up in your accounting records the same way too.
To document an owner’s draw, you will need to decrease your business’s cash balance and retained earnings accounts by crediting the former and debiting the latter.
Unlike a salary, owner’s draws don’t have to follow a schedule or stick to a fixed amount unless you set them up as a guaranteed payment in your operating agreement. As a result, you can adjust them to match your business’s cash flow throughout the year.
Using software to track your business transactions makes maintaining your financial statements much easier. Fortunately, Sunrise offers free accounting software for small business. Give it a try today!
How Are Owner’s Draws Taxed?
Taking an owner’s draw from an LLC is generally a non-taxable event. However, that doesn’t mean you don’t pay taxes on the amount. Instead, you incur your tax liability on those funds prior to the owner’s draw, so the transfer is mostly irrelevant.
Single-member LLCs taxable as sole proprietorships are pass-through entities in the eyes of the IRS. That means the IRS disregards them for tax purposes, and you won’t pay any corporate tax for the company.
As a result, your business income is taxable at the personal level whether or not you withdraw it. The tax liability for whatever money you generate automatically flows through to your personal tax return.
Because you’re not taking a salary, you can’t pay your taxes through withholding from your payroll. Instead, you’ll need to make estimated tax payments each quarter throughout the year.
Here’s an example to demonstrate how it works. Say you’re the sole LLC member of an LLC taxable as a sole proprietorship. In 2021, you earn $100,000 in net income through your business.
At this point, you already know you’ve generated $100,000 in taxable earnings and would owe income tax and self-employment tax on the entire amount.
You then decide to take $75,000 in owner’s draws and leave $25,000 in the business bank account to cover upcoming company expenses. However, that doesn’t impact your tax liability for the year. You still pay taxes on the $100,000 of earnings.
Do I Need To Pay Payroll Taxes?
If you own a profitable single-member LLC, you’re going to owe payroll taxes. However, the portion of your income subject to them varies depending on your business entity’s tax treatment.
Remember, “payroll tax” is a term that includes multiple subsidiary taxes. Generally, the most significant payroll taxes are the Federal Insurance Contributions Act (FICA) taxes: 12.4% tax for Social Security and 2.9% tax for Medicare.
If your single-member LLC is taxable as a sole proprietorship, you’ll need to pay FICA tax on your business’s net earnings each year. Whether you pay yourself via owner’s draws or keep the money in your company, your FICA tax liability will be the same.
However, it’s more common to refer to these taxes as self-employment taxes in this situation since you’re not actually running payroll. That said, these are the same taxes that businesses running payroll incur on any wages paid.
For example, if you file an election to treat your single-member LLC as a corporation, you’ll generally need to pay FICA taxes on your reasonable salary.
Consider Consulting a Tax Expert
The average independent contractor has a more complicated personal tax return than the typical employee. As a result, it’s often worth engaging a Certified Public Accountant (CPA) as a small business owner, even if you’re operating as a sole proprietor.
If you’ve formed a single-member LLC and want to optimize the way you pay yourself for tax purposes, your business is almost certainly complex enough to warrant hiring a CPA.
The price of their services is a tax-deductible business expense, and they’ll likely save you enough in taxes to justify the cost. Consider getting expert tax advice today!
Accounting software makes tax time much easier for you and your CPA. Fortunately, Sunrise offers a free small business accounting app. Give it a try today!
*The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.