As the owner of an LLC (Limited Liability Company), you can pay yourself a salary or draw distributions from the company’s profits.
However, it’s essential to understand the distinction between these two methods of compensation and how they affect your LLC’s finances and tax reporting…
- Salary –
- If you pay yourself a salary as an employee of the LLC, the salary is considered a business expense, and it’s deductible for the company. The LLC must withhold income taxes, Social Security taxes, and Medicare taxes from your salary, just like it would for any other employee.
- You’ll need to set up a payroll system and comply with federal and state payroll tax requirements, including making payroll tax deposits and filing payroll tax returns.
- Paying yourself a reasonable salary ensures that you’re compensated for your work and contributions to the business, and it helps establish a clear distinction between employee compensation and distributions of profits.
- Distributions –
- As an LLC owner, you can also take distributions of profits from the company. Distributions are not considered business expenses because they represent a transfer of profits from the company to the owners.
- Distributions are typically reported on the owner’s personal tax return (Form 1040) and are not subject to payroll taxes such as Social Security and Medicare taxes. Instead, they may be subject to income taxes and, in some cases, self-employment taxes, depending on the owner’s total income and the LLC’s tax classification.
- Unlike salary payments, distributions do not require withholding taxes, and they do not affect the LLC’s bottom line for tax purposes. Instead, they reduce the LLC’s retained earnings and the owner’s equity in the company.
It’s essential to strike a balance between paying yourself a reasonable salary for your work and contributions to the business and taking distributions to share in the company’s profits. Paying yourself solely in distributions without any reasonable salary can raise red flags with the IRS if it appears that you’re trying to avoid payroll taxes.
Before determining how to compensate yourself from your LLC, consider consulting with a tax professional or accountant familiar with small business taxation. They can help you understand the tax implications of different compensation methods and ensure that you’re complying with IRS rules and regulations. They can provide guidance on structuring your compensation in a tax-efficient manner that meets your financial needs and objectives.
