Today’s post is all about how to pay yourself as an LLC.
Here at LYFE Accounting, not only do we help people pay themselves correctly as an LLC…
…but we’ve also started one of the fastest-growing LLCs according to Inc Magazine and the financial times in 2021.
So now, we want to walk you through how we pay ourselves as LLC owners, and how we advise our clients to pay themselves through an LLC.
Alright, so you are living the dream. You work for yourself, your business is earning money, and now it’s time to make some decisions – how do you pay yourself?
If you pay yourself too much, you might risk putting your business in a bad financial situation.
If you pay yourself too little, you might be overwhelmed by all of the taxes you owe as an LLC.
And speaking of taxes, how exactly does that work when you pay yourself? Should it be deducted from your paycheck, paid quarterly at tax time, or what?
If this is you, then stick around until the end because we are going to cover everything you need to know about both – the financial aspects of paying yourself and the tax side.
So let’s begin!
How to Pay Yourself as an LLC
You’ve probably heard of several ways of paying yourself from your business – like dividends, distributions, draws, W-2 wages, and so much more.
As an LLC, the best way to pay yourself is through an owner’s distribution, which is also known as an owner’s draw.
Think of an owner’s distribution as a transfer of money. You are simply transferring money from your business to your personal bank account.
You can literally write yourself a check, go to the bank, or simply wire funds from your business bank account directly to your personal bank account to pay yourself.
You don’t need to worry about setting up payroll accounts, withholding taxes, or anything like that, unless you are electing to be taxed as an S-Corporation.
How Taxes Work for LLC Pay
As the owner of an LLC, you are a shareholder, not an employee. Because of this, you do not have to pay yourself W-2 wages. Only employees are paid wages.
When you are an employee, taxes are automatically deducted from your paychecks before it hits your bank account.
But when you own an LLC, your taxes are not automatically deducted from your distributions.
In fact, your LLC taxes have absolutely nothing to do with how much you pay yourself from your business.
LLC taxes are based on the business’s taxable income.
This is simply revenue minus expenses. Or in other words, the money the business earns minus the business expenses it incurs.
As the owner of an LLC, your taxable income is based on what you own.
If you own 100% of the LLC, then 100% of the business income would be reflected as your individual income when you file your taxes.
Because you own the company, none of the distributions you pay yourself are tax-deductible.
You see, technically, LLCs are what are referred to as “pass-through entities”.
This means that the business’s taxable income is allocated directly to the owners, to pay on their individual tax return.
Basically, in the eyes of the IRS, the business’s income is your income.
For example, if your business earns $100,000 in taxable income, but you only pay yourself $10,000, you are still going to pay taxes on the full $100,000 that you earned.
We can’t tell you the number of times that we have had people tell us that their tax bill was wrong because they only paid themself X or Y from their business.
The IRS does not care how much money you pay yourself from your LLC.
That’s your business. Literally.
The IRS is looking at the income your business reports, and you report that income like it’s your own when tax time comes around.
Generally speaking, you will pay…
- federal income taxes,
- state income taxes, and
- self-employment taxes
…on the amount you report.
However, if you elect S-corp status, you can potentially limit the amount of self-employment taxes you pay.
How Much Should You Pay Yourself From Your LLC?
Because you’re taxed on all of your business income, you might think that it’s best to go ahead and pay yourself 100% of your business income since you’ll be taxed on it.
But it’s not so simple.
You have to think about what your business needs. And you should also plan to pay your estimated taxes.
So let’s talk about it.
First and foremost, let’s be clear – cash is the lifeline of your business. It’s the blood and heartbeat of your business. And if you starve your business of it, you will die.
This is a fact. 90% of businesses fail because they run out of cash.
Think of cash like fuel, the less cash your business has in the tank, the shorter the distance it can go.
And too many times, business owners take so much cash out of their business, that they don’t even leave enough to pay their expenses.
Like seriously, we’ve seen businesses pay themselves a ton of money and not have enough money left in the payroll to even pay their employees.
That aside, you’re also draining your business potential when you take too much cash out of your business.
Some of the fastest-growing companies grew quickly because they consistently re-invested capital into their business.
For example, a lot of people don’t know this but Amazon, which is now one of the largest businesses in the world, was technically “unprofitable” for the first 14-years of their business.
And it wasn’t due to poor budgeting or expense management.
They were consciously re-investing into their business.
So as a result, they grew exponentially faster than anyone could have imagined, have revolutionized their industry, and is now one of the largest companies in the world.
Jeff Bezos could have easily been greedy in his early years, but he wasn’t. And now, greedy people envy his success.
Anyway, our point here is that before you consider taking a dime out of your business…
…you need to make sure that your expenses will be covered, and that you’re not starving your strategic goals which require money to grow your business.
Now that that’s out of the way, these are the steps we take when paying ourselves from our LLC, and what we recommend for any other business.
Steps You Need to Take When Paying Yourself as an LLC
1. You should have at least 3 months of operating expenses in cash.
This will provide you security and peace of mind that your business can stomach any unexpected losses and stay afloat.
So if you lose your biggest customers, or the economy crashes, you weather that storm with this reserve.
2. You should set money aside to reach your strategic business goals.
Whether that’s more marketing, new products, buying new technology, or simply investing in your existing products or services to increase your satisfaction.
Whatever it is, set the dollar amount that you will invest in it, and leave that in cash.
3. You should set money aside to pay your estimated quarterly taxes.
You should pay at least 90% of what you estimate you will owe in the current tax year on a quarterly basis or 100% of the prior year’s liability.
Finally, you can pay yourself all that is left in your business.
Any excess cash can be paid to you in a distribution or divided amongst your partners according to your respective equity in the business.
Now if you want to make sure your LLC taxes are on the right track, then we can help you with that.
Check out our tax planning and tax preparation services here.