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ndependent contractors and small business owners have several options for classifying their businesses and getting paid. One of the most popular options is classifying a business as a Limited Liability Corporation (LLC).
LLCs are popular because they combine some of the benefits of sole proprietorship with the benefits of owning a business. When classified as an LLC, your personal assets—like your house and car—are protected even if your business goes under or faces a lawsuit.
But before you transition from a sole proprietorship to an LLC, it’s important to have your ducks in a row. One of the biggest challenges of owning an LLC is understanding how to pay yourself. Let’s take a closer look.
How do you pay yourself as an LLC?
When you own a sole proprietorship, money can move directly from your clients to your bank account with minimal lag time or extra steps involved. You’re responsible for tracking that money for tax purposes, but you don’t have to move it around within your bank accounts if you don’t want to.
Things are a little less simple when your business becomes an LLC. Instead of you and your business being synonymous, there is a layer of separation. Clients don’t pay you directly. Instead, they pay your business. You then have the option of re-investing the money into your business or using the money to pay LLC members (aka, anyone who is a part of the LLC).
If you choose to pay yourself, you have three major options: making an owner’s draw, paying yourself as an employee, or paying yourself as an independent contractor.
Making an owner’s draw
When you own or co-own a business, a portion of the business's finances legally belong to you. An owner's draw is an official way to take that portion of business finances out of the business and put it into your personal bank account. Single-member LLC owners can always make an owner's draw, as can multi-member LLC co-owners, as long as they haven't classified their business as a corporation.
Making an owner's draw is generally a simple process. All you have to do is write yourself a check or transfer the money from your business's bank account to your personal bank account.
Single-member LLC owners can withdraw as much as they want at a time as long as they leave enough in the business bank account for the business to continue operations. For multi-member LLC owners, things get a little more complicated. You and your partners will need to discuss what portion of the company's profits belong to each and how often you can each make owner's draws.
Paying yourself as an employee
A second option to paying yourself as an LLC is to treat yourself the same way you would treat any other employee. This means you fill out a W-2 and then pay yourself a standard salary on a regular pay period, pulling taxes out of your paycheck as you go.
If you're a single-member LLC or part of a multi-member LLC that hasn't asked to be a corporation, you are not eligible to pay yourself as a W-2 employee. However, if you are part of a multi-member LLC and ask for your business to be considered a corporation (such as an S-class or a C-class LLC), you must pay yourself as a W2 employee.
If you’re paying yourself as a W-2 employee, the federal government requires you to pay yourself a “reasonable rate.” Your pay should be commensurate with any other professional doing the type of work you’re doing for the amount of time you’re doing it.
Paying yourself as a W-2 employee is a great way to provide your family with stable, predictable funds as long as your business makes consistent capital and can support the required payments.
Paying yourself as a 1099 contractor
The third option for paying yourself as an LLC is to treat yourself the way you would treat an independent contractor. This means you essentially "hire" yourself to do a certain amount of work, fill out a 1099 form, and have the business pay you at specific times for the work you contracted yourself to do.
Paying yourself as a 1099 contractor allows you to pay yourself more ad hoc than if you classify yourself as a regular employee. However, taxes can get complicated because you have to pay business taxes as well as self-employment taxes. As a result, paying yourself as an independent contractor isn’t super common within LLCs. It usually only happens if there are multiple business owners.
Are there any downsides to paying yourself as an LLC?
When you think about paying yourself, it’s tempting to give yourself 100% of your business profits every month. However, this may not be the best option. Paying yourself too much makes it look like your business doesn’t generate much of a profit, which can make it difficult to apply for a small business loan.
On the other hand, if you don’t pay yourself enough in an attempt to minimize personal income, the IRS may charge you with tax evasion.
This can be a bit of a balancing act. The key to getting this right is to focus on keeping excellent books. Use any money you keep in your business for business expenses, such as office space or advertising. Any money you need for personal expenses—like food or housing—needs to come from the money you paid yourself.
You should also pay attention to common pay rates in your area. Be sure to pay yourself a salary commensurate with the work you’re doing.
How are LLCs taxed?
One of the benefits of owning an LLC is that you don’t pay taxes on the LLC itself. Instead, you account for your business’s profits or losses when you file your personal income taxes.
For single-member LLCs, this is a pretty straightforward process. All you have to do is fill out Form 1040, Schedule C, and report your business’s income and expenses.
However, if you’re a multi-member LLC, you hire employees that you have to pay, or you pay yourself as a W-2 employee, a little more goes into this process. Members have to agree on how they’re sharing the LLC profit. Each member is responsible for paying taxes on 100% of their profit share, whether or not they’ve withdrawn that amount from the business. Meanwhile, if you’re paying employees (including yourself) using W-2 forms, you’ll have to both collect and pay payroll taxes.
Tax laws for LLCs can get complicated, so it may be best to work with an accountant, especially for your first few years. This can help you get a handle on things like bookkeeping, tax deductions, and expense tracking.
What are the alternatives to paying yourself as an LLC?
One of the top alternatives to paying yourself as an LLC is to reinvest your profits into your business. The IRS taxes your profits, not your income, which means it taxes the difference between your business’s income and expenses. The higher your business expenses, the lower your profit tends to be.
Of course, this doesn’t mean you can—or should—spend frivolously to reduce your profit margins. But it does mean that if you have major business investments you were planning to hold off, it may behoove you to make those investments instead.
Alternatively, you can avoid paying yourself as an LLC by remaining a sole proprietorship or transitioning to a C-Corp or S-Corp. These business options have different tax rules, which are worth considering before you decide how to classify your business.
When you become an LLC, you are responsible for paying taxes on your business’s profits. You also must pay yourself a reasonable income for the work you do. If you don’t pay yourself suitable wages, the IRS is likely to audit you to see where your business’s income is going.
Regardless of how you pay yourself as an LLC, you will need to track your income, expenses, and payments. Novo can help.
Novo is a business banking platform that empowers business owners with the tools they need to manage their finances quickly and easily. Visit us today for more information on how Novo can facilitate your financial management.
Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.
Novo is a fintech, and not a bank. Novo acts as a service provider to Middlesex Federal Savings, F.A., and the deposit and banking products obtained through the Novo platform are provided by Middlesex Federal Savings, F.A.
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