How to pay yourself from your LLC: A small business start-up guide

In this Article:

• What is an LLC?
• Benefits of an LLC structure
• How to pay yourself as an LLC
• Methods to pay yourself
• Tax implications when paying yourself
• Setting up payroll for your LLC
• Accounting and bookkeeping for LLC owners
• Legal and compliance considerations
• Best practices for paying yourself from your LLC
• Common mistakes to avoid
• Frequently asked questions

Establishing and managing a limited liability company (LLC) offers business owners flexibility, personal liability protection, and attractive tax advantages. But how exactly do you pay yourself through an LLC, and what are the different methods to do so? Let's dive in.

What is an LLC?

A limited liability company (LLC) is a popular business structure that blends the liability protection of a corporation with the tax benefits and operational flexibility of a partnership or sole proprietorship. This structure may safeguard your personal assets from the company’s liabilities, meaning that legal issues or debts incurred by the business generally do not affect your personal finances.

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Benefits of an LLC structure

There are quite a few benefits to using an LLC structure. Instead of being taxed at the corporate level, profits and losses “pass through” directly to the owners’ personal tax returns, avoiding double taxation. Owners (members) of an LLC also may enjoy protection against business debts and legal judgments. Lastly, LLCs generally have fewer record-keeping requirements and more flexible management structures compared to corporations.

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How to pay yourself as an LLC

When it comes to compensating yourself, the choice largely depends on how your LLC is managed and how profits are distributed.

Member-managed vs. manager-managed LLCs

In member-managed LLCs, every member actively participates in day-to-day operations. This model suits businesses where all owners are involved. Meanwhile, in manager-managed LLCs, designated managers handle operational decisions. This structure is ideal if some members prefer to be passive investors or if the business requires professional management.

Distributions vs. salaries

Distributions are withdrawals of profits from the LLC. They’re generally not subject to standard payroll tax withholding, but members must account for self-employment taxes on these earnings. A salary, on the other hand, means receiving regular wages subject to payroll taxes, with withholding requirements and additional compliance measures.

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Methods to pay yourself

There are two primary methods of compensating yourself as an LLC owner: using an owner’s draw or paying yourself a salary.  

An owner’s draw involves withdrawing profits directly from the business’s earnings. This allows for flexible access to funds and less administrative overhead (if you aren’t running a formal payroll system) but can complicate tax filings overall.

Paying yourself a salary is suitable if you’re actively involved in running the LLC and wish to ensure a steady, predictable income. Not only does this provide a regular income for personal budgeting, but it also establishes a clear payroll record, which may simplify tax filings and future financial scrutiny. However, this method requires setting up and maintaining a payroll system and is subject to additional payroll tax compliance and administrative tasks.

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Tax implications when paying yourself

Understanding the tax implications is crucial for both methods:

• Self-Employment taxes
   LLC members generally must pay self-employment taxes on their share of the income if they do not opt for a salary structure.
• Estimated taxes
  Regardless of the payment method, making quarterly estimated tax payments may be essential to avoid IRS penalties.
• Payroll taxes
  If you choose to pay yourself a salary, you generally must withhold payroll taxes, which include Social Security, Medicare, and income tax withholdings, and remit them to the IRS.

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Setting up payroll for your LLC

For those who opt to pay themselves a salary, establishing a structured payroll system is critical.

1. Obtain an employer identification number (EIN). This unique number is required for payroll and tax reporting.
2. Choose a payroll system or software. Opt for a solution that integrates seamlessly with your accounting system and simplifies tax calculations.
3. Comply with payroll regulations. Abide by both federal and state regulations regarding wage payments, tax withholdings, and payroll filings.

When picking a payroll system for your LLC, ensure you get something that not only integrates with your existing accounting system, but automates tax calculations and reminders for filings and provides clear records for both internal and external audits.

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Accounting and bookkeeping for LLC owners

Accurate bookkeeping is critical for tracking income and expenses to help ensure that tax returns are precise and provide clear records in the event of an audit. To achieve effective bookkeeping, it’s advisable to use accounting software such as QuickBooks, Xero, or FreshBooks, which can greatly simplify the record-keeping process. Additionally, maintaining separate bank accounts for your business and personal finances may prevent the commingling of funds, reinforcing financial clarity and security. Regular reconciliation of your bank statements with your accounting records is also essential, as it helps you catch and address discrepancies early on, which help ensure that your financial records remain accurate and reliable.

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Legal and compliance considerations

Ensuring that your LLC complies with all applicable laws is essential. This means meeting federal regulations related to taxation and labor while also adhering to state-specific requirements that could impact payroll, business operations, or licensing. Equally important is following IRS guidelines meticulously. This includes accurately classifying income—whether as distributions or salaries—processing payroll and withholdings according to current standards and completing both quarterly and annual tax reporting. By staying on top of these legal and regulatory obligations, you help secure your LLC’s financial stability and protect it from potential compliance issues.

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Best practices for paying yourself from your LLC

• Establish a regular payment schedule. Consistency in payments helps with personal budgeting and cash flow management.
• Set aside funds for taxes. Allocate a portion of your income specifically for tax obligations, reducing the risk of unexpected liabilities.
• Keep personal and business finances separate. Maintain separate bank accounts and avoid commingling funds to reinforce liability protection and simplify accounting.

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Common mistakes to avoid

• Mixing personal and business funds: Commingling funds can confuse tax records and jeopardize your liability protection.
• Ignoring tax obligations: Missing estimated or payroll tax payments can result in steep IRS penalties.
• Inconsistent payments: Irregular compensation may lead to personal budgeting challenges and cash flow issues for the business.

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Frequently asked questions

What is the best way to pay yourself as an LLC owner?

The ideal method depends on your financial situation, business structure, and personal needs. Some owners benefit from the flexibility of an owner’s draw, while others find paying themselves a salary more sustainable. Consulting a tax professional can provide tailored advice.

How much should I pay myself from my LLC?

Determine a reasonable compensation based on your business’s profitability, your role in the company, and the associated tax implications.

Do I have to pay self-employment tax on my LLC income?

Yes, if you take distributions (owner’s draws) and are actively involved in the business, your share of the income is generally subject to self-employment tax.

Can I change the way I pay myself from my LLC?

Absolutely! As your business grows and your financial circumstances change, you can adjust your compensation method. Just be sure to remain compliant with IRS regulations.

What are the risks of not paying myself properly from my LLC?

Improper payment methods can expose you to tax penalties, legal complications, and potential financial instability.

How often should I pay myself from my LLC?

Establish a regular payment schedule that aligns with your business cash flow and personal budgeting needs to maintain financial discipline.

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