As a small business owner, how you pay yourself depends on your business’s legal structure and how you elect to pay taxes. The Limited Liability Company (LLC) is a popular legal entity offering liability protection to its owners (called members), simple compliance requirements, and tax flexibility. In fact, tax flexibility is one of the reasons the LLC is such an appealing option for small business owners.
Should an LLC Owner Be on the Payroll?
If you’re thinking about starting an LLC, you have several options for how you want to organize your company regarding paying taxes. Whether or not the owner is on payroll depends on how you decide to file:
- A sole LLC business owner is called single-member LLCs and can file taxes as a Sole Proprietorship, a C Corporation, or an S Corporation.
- When there is more than one owner, it is called a multi-member LLC, which can file taxes as a Partnership, a C Corporation, or an S Corporation.
Each tax election determines how you pay yourself from your LLC.
Learn More: What is Payroll?
What Tax Options Does an LLC Have?
Single-member LLCs Filing as a Sole Proprietorship
- By default, the Internal Revenue Service (IRS) classifies a single-member LLC as a disregarded entity, which means the Limited Liability Company files taxes as a Sole Proprietorship.
- Sole proprietors are not employees of the company, and therefore, do not receive a W2.
- As a Sole Proprietorship, the company’s finances are reported as business income and losses on the owner’s personal Schedule C tax form.
- Therefore, the taxes that are owed depends on the owner’s individual tax rate. In addition, the owner is also responsible for paying self-employment taxes (Social Security and Medicare).
Multiple-member LLCs Filing as a Partnership
- When the LLC has more than one owner, it is referred to as a multi-member LLC and files taxes as a Partnership by default. Partners and owners are also not considered company employees and do not receive W2s.
- Like the Sole Proprietorship, the company’s income and losses are distributed to the partners and reported on their individual tax returns.
- Typically, profits and losses are divided equally among the partners. Still, there are circumstances where the partners are not equal due to the money each invested or the time they spend running the daily operations. In those cases, the partnership agreement documents how the business income is divided.
- Partnerships report business income on the 1065 partnership tax return, and members pay self-employment taxes on their shares of the business income.
LLCs Filing Taxes as a C Corporation
- Single-member LLCs and multi-member LLCs can also elect to file taxes as a C Corporation. In a C Corporation, all members are considered employees of the company and must receive a W2.
- The company pays the members (and any other workers) a salary and does not pass income and losses onto its members. Instead, the company’s profits and losses are reported on the LLC’s tax forms, and the company pays business taxes, including its portion of employment taxes.
- Members then pay taxes on their salaries, which is why the C Corporation is referred to as having double taxation. LLCs with high profits may decide to file taxes as a C Corporation because passing profits to owners might generate inflated personal income and high individual tax rates.
- To file taxes as a C Corporation, the LLC must claim its intention by submitting IRS Form 8832 and then Form 1120, the U.S. Corporation Income Tax Return. In addition, any dividends the LLC chooses to disburse to owners/members must be reported on the owners’ tax returns at the qualifying dividend rate.
- C Corporations pay a flat corporate tax of 21%, which may or may not be better than the members’ personal rates, so it’s crucial to check with your accountant.
LLCs Filing Taxes as an S Corporation
- Finally, an LLC can choose to elect S Corporation status and avoid the double taxation associated with a C Corporation.
- As an S Corporation, the LLC can decide how much of the company’s profits are allocated to salary and how much to dividends. Only the salary portion is subject to self-employment taxes, so the members can possibly save more in taxes.
- To elect S Corporation status, the LLC must file IRS Form 2553 by March 15 of the current tax year. The LLC/S Corporation then files a 1120S tax return, with members receiving a Schedule K-1 form indicating their share of the profits and losses.
What is a W2?
I mentioned a W2 many times above and you might be asking what that is. A W2 form provides important information about the income you’ve earned, the amount of taxes withheld from your paycheck, any benefits provided, and other payroll information for the year. You’ll use this W2 form to file your federal and state taxes.
Does an LLC Pay into Social Security?
In general, all workers, including business owners, pay Social Security and Medicare taxes (called FICA) unless income is below $400 for the year. The Social Security tax rate on taxable wages is 6.2% each for the employer and employee or 12.4% for both. The Medicare tax rate is 1.45% each for the employee and employer.
In addition, employers are responsible for paying state unemployment taxes for each employee (the rate varies by state). Sole Proprietorships, general partners, and LLC members treated as Partnerships do not pay state unemployment taxes.
Learn More: Registering for Payroll Taxes
Can I 1099 Myself From My LLC?
Another option for paying yourself is having the LLC hire you as an independent contractor. You are still responsible for paying self-employment taxes, and you must follow the rules for independent contractors. What kind of tax benefits are still available to your company, and as an LLC are not as clear, so it’s essential to talk to your accountant before using the IC option.
Learn More: Independent Contractor vs. Employee
How Much Should an LLC Owner be Paid?
Many factors go into knowing how much to pay yourself and it goes beyond what the company can afford. How the LLC files taxes is a significant consideration because you want to keep as much money in the company as possible to grow the business. But there’s also the matter of what is considered reasonable compensation for your industry, the responsibilities you carry, and how much you need to survive, such as house payments, transportation, family needs, etc.
What is an Owner’s Draw?
Single-member LLC owners don’t have traditional salaries and wages. Most LLC owners will pay themselves by taking money out of the LLC’s profits (revenue less expenses). That process of extracting money from the LLC’s bank account is referred to as an owner’s draw. LLC can simply write themselves a check or transfer the money from the LLC’s bank account into their personal bank account.
There’s a lot of flexibility with LLCs, so when you’re ready to make financial tax decisions, we recommend LLC members talk with an accountant or tax professional.
If you’re thinking of switching structures to an LLC, CorpNet is always here to help with business formation and compliance requirements. Contact us today to discuss your business’s needs!