If you're a small business owner operating under an LLC (Limited Liability Company), you've probably wondered, "How do I pay myself?" Whether you're just starting or have been in business for a while, understanding how to pay yourself properly is critical for staying compliant with tax laws and maximizing financial benefits. So let’s dive deeper into how to compensate yourself as an LLC owner—and explore some extra tips to leverage your business structure for tax advantages!
The Basics: Single-Member LLC vs. Multi-Member LLC
If you're running a single-member LLC, you’re operating what's known as a disregarded entity for tax purposes. This means that the IRS treats you similarly to a sole proprietor, but you’ve got one key advantage—liability protection. Your personal assets are separate from your business, so you’re not personally liable for business debts. However, for tax purposes, it’s as if the business and you are the same.
When you set up your LLC, you probably obtained an EIN (Employer Identification Number). Think of it as a Social Security number for your business. It allows you to open a business bank account, establish credit, and manage your business finances. But how do you pay yourself once you’ve earned money in your business?
For single-member LLCs, the most common way to pay yourself is by taking a distribution. Here’s how it works:
Pretty straightforward, right? But here’s the catch—distributions aren’t tax-deductible for your business. That means while you can take out as much as you want, the business doesn't get a tax break for paying you. You’re still taxed on the income through self-employment taxes, which can be a hefty 15.3% on your total earnings.
This is where things get tricky. As your business grows, relying solely on distributions becomes less advantageous due to the lack of tax savings. Enter the S-Corporation.
When your LLC is making good money, it may be time to consider transitioning to an S-Corp election. This allows you to pay yourself a reasonable salary and take additional earnings as distributions, which aren’t subject to self-employment taxes. This strategy can save you thousands in taxes!
Here’s what you need to do to switch:
Once your LLC becomes an S-Corp, you must pay yourself a reasonable salary. But unlike distributions, this salary is taxable. The good news? Anything over your salary can be taken as a distribution, avoiding the 15.3% self-employment tax on that additional income.
Before diving deeper into the advantages of an S-Corp, let’s not forget the critical role of your EIN. Having an EIN is crucial not just for tax purposes but also for growing your business. It’s your business’s official identifier, much like a Social Security number, and allows you to:
Without an EIN, you won’t be able to establish your LLC’s separate financial identity, which is important for liability protection and financial growth.
Let’s break down the tax savings with an example. Suppose your business earns $100,000 in profit.
If you're a single-member LLC, you’d pay self-employment tax (15.3%) on the full $100,000, amounting to $15,300 in taxes. Ouch!
Now, let’s compare that with an S-Corp. You decide to pay yourself a reasonable salary of $30,000. You’d pay self-employment tax (7.65%) on that amount, but the remaining $70,000 can be taken as a distribution and won’t be subject to self-employment tax. That’s a significant tax saving!
Additionally, under the S-Corp, you’re eligible for the Qualified Business Income (QBI) deduction, which allows for a 20% deduction on business income you didn’t pay yourself. This can further reduce your tax liability.
When you're a single-member LLC and you pay yourself through distributions, you don’t get a tax deduction for that payment. Many LLC owners assume paying themselves is similar to paying employees, where wages are deductible for the business—but this isn't the case. Only when you hire employees can your business deduct those wages, not when paying yourself as the owner.
This is one of the main reasons LLC owners often switch to S-Corp status as their business grows. By paying yourself a reasonable salary under an S-Corp, you’re able to deduct that salary from your taxable business income.
One of the most important aspects of being an S-Corp owner is determining what constitutes reasonable compensation. A good rule of thumb is to pay yourself at least 30% of your net income as salary. This percentage is based on your business’s net income after deducting all business expenses.
For example, if your business generates $100,000 in net income, you’d want to pay yourself a salary of at least $30,000. The rest can be taken as distributions to avoid the self-employment tax on the remaining $70,000.
One major advantage of the S-Corp structure is flexibility with payroll. You don’t have to pay yourself every month. In fact, many S-Corp owners opt to do a one-time payroll at the end of the year after calculating their net income. This gives you more control over your cash flow and helps you avoid overpaying in taxes before you truly know how much you’ve earned.
By the end of the year, once you have a clear picture of your finances, you can calculate your reasonable salary and handle the payroll accordingly. This strategy can keep more cash in your business throughout the year and help you budget for taxes more effectively.
You may be wondering when it makes sense to switch from an LLC to an S-Corp. The general rule is that if your business profits are $40,000 or more, the tax savings from electing S-Corp status often outweigh the additional administrative work and payroll taxes.
Paying yourself as an LLC owner doesn’t have to be complicated. Start by paying yourself through distributions if you're just getting your business off the ground. But as your profits increase, consider switching to an S-Corp to enjoy the tax benefits.
Remember, consulting with a tax professional is crucial to ensure you’re following the right steps for your business. As your business evolves, so should your tax strategy. Stay informed, plan ahead, and keep building your business!
Got more questions about LLCs, S-Corps, or taxes? Drop them in the comments, and don’t forget to subscribe for more insights on growing your business!
Ready to dive deeper and tailor a strategy specifically for your needs? Set up a FREE discovery call with Tax Code Advisors to learn more.
Stocks Investment HSA Health Buy Rent Real Estate Rates Financial freedom Retirement planning Financial freedom number Withdrawal rates Investment strategies Long-term financial planning Debt management Tax planning Personal finance Cash Flow Accounting Business Tax Strategies HRA Medical Insurance Buy-Sell Fraud Partnerships Partners Tax Case llc payroll Tax Tax Strategy
