As a new LLC member, one question that has run around your mind more times than you can recall is… 'How do LLC members pay themselves'? Your questions are answered here.
You've probably heard the term LLC one too many times. Some might know what it stands for, while others might not. An LLC stands for a Limited liability company. They are companies that protect business owners from their personal debts and liabilities.
Before we dive deeper into what LLCs do, we should define a liability.
A Liability is any money or service owed to another party. Even tax is a liability as long as it doesn't belong to your company or business it is a liability.
What is the job of an LLC?
An LLC is meant to protect business owners from being personally pursued by debts and liabilities incurred from business resources and other business expenses (Check CEO Creative for business resources and items that will be worth your liability). Depending on the State the LLC is situated in, the rules of debt or liability payment will differ.
Who is an LLC member?
Contrary to what you might think, an LLC member is not one who signs up to have its debt and liabilities protected by the company but rather an LLC owner or owners, as the case may be.
Now the burning question is, "How do LLC members pay themselves"? Here is how.
As with every other business, LLCs can be single-handedly owned, multi-membered, or corporate. Depending on the type of LLC, you could pay yourself through a method called the owners draw or via a real payroll system.
The three types of LLCs are identified based on their tax status:
Single-member LLCs - these are limited liability companies with one sole owner. They are regarded as sole proprietors for tax purposes.
Multi-member LLCs - as the name implies, these LLCs have more than one member and are treated as partnerships for tax purposes.
S-Corp Taxed LLCs- this is where it gets tricky. This LLC can be a single member or multi-member LLC that wants to be taxed as an S-Corporation must file Form 2553, Entity Classification Election, with the IRS.
How LLC members pay themselves depends on the type of LLC being run. S
For a Single Member LLC, when the IRS taxes it as a Sole Proprietorship, the owner is one, and the LLC is frequently viewed as a Disregarded Entity. The owner has the right to withdraw any amount through the owner's draw. After all, you are your business. You can pay yourself with a check or cash or simply transfer to your personal bank account. Just ensure that you note in your Accounting System that you are paying yourself. Pro tip? Leave enough money in the business account to allow the LLC room to breathe.
In the case of a Multi-member LLC, however, where the business is taxed as a partnership business, they also pay themselves with owner’s draws. Same method as the single-member LLC, however, it is split amongst the members. They are regarded as pass-through entities by the IRS, which means that although they are identified by the IRS and need to submit an income report, the entity itself is not taxed. Wild guess? The IRS wants to avoid disputes among the members, so they keep tabs on each one. I am kidding here…
For the last type of LLC, the Corporate LLC, the members pay themselves through salaries and/or distributions. Some LLCs elect to be recognized as corporations (S-Corporations or C-corporations). In this case, the owner's draw option is canceled. A payroll system (like Gusto) is brought into play. Each member is treated as an employee getting a salary equal to the amount they'll get in a standard business setting for doing a job similar to what they are doing at the LLC. The bonus can be paid based on the business profits quarterly, annually, or whatever the company chooses. Still, it is taxed as the corporation's earnings, albeit a profit from business projects, which can definitely save lots of money on self-employment taxes.
What exactly is an owner's draw?
For a single-member LLC, this involves disciplining yourself and giving yourself a payday and a good paycheck that doesn't leave the business wanting. What is a business without bookkeeping? Even a sole proprietor one. A book record of your draw must be kept, which is why paying yourself in cash is inadvisable. For a multi-member LLC, this will alert the IRS since they keep tabs and reconcile business and personal financial activity.
The three best ways to issue the owner draw are;
Issuing of writing a check
Making a bank transfer
Payroll software providers
For a business whose sole purpose is managing other business liabilities and taxes, getting taxed is surprising, right?
How does the IRS tax LLCs?
For a single-member LLC, the taxing system covers the whole income. That is, the entire revenue is taxable. One of the reasons why good keeping is required is that regardless of how much you draw as your income tax remains the full bale of your LLCs profit.
In the case of a multi-member LLC, which is recognized as a partnership by the IRS, there is no need to file a separate business tax return, unlike the single-member LLC. Each member's income is taxed based on their share of the profit. They have different share values, after all, and as in the case of a single-member LLC, they must also pay self-employment tax. Multi-member LLCs are also to file IRS form 1065 and a schedule K-1.
Taxing a corporate LLC is handled the same way other businesses are run with the IRS withholding taxes before paychecks are issued. There are two cases of the C-corporation - for corporations under this segment, a business tax return must be filed, which implies taxation possibly on two levels. Business level and personal level. The S-corporation, however, passes income directly to the owner.
Lastly, just be sure to find a balance when paying yourself and your fellow members. You don’t want to drain all of your profits and not be able to continue to grow your company. If you need a budget spreadsheet, you can access my template here for free. And if you need to get yourself set up with a payroll provider, I recommend Gusto.
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