Have you recently registered your business as a limited liability company (LLC)? Are you thinking of making the leap into starting your own business?
If you’re completely overwhelmed about how your LLC translates during tax season, you’re not the only one. It can be confusing to navigate taxes as an LLC, so we’ll break it down for you in this handy guide.
The 3 most common self-pay options
What are your options when it comes to paying yourself from your business?
There are 3 primary ways that those under the LLC umbrella can choose to receive payment from their business:
- Some entrepreneurs choose to pay themselves as an employee of their business
- Others opt to pay themselves as a member of the LLC
- Some business owners hire themselves as independent contractors
What is the difference when it comes to tax time?
Simply put, considering yourself an employee of your LLC will require you to have tasks and responsibilities. You would need to work within the company as an hourly or salaried employee.
If you chose to pay yourself as a member, then you would not necessarily be committed to a certain role or set tasks. You would have a couple of options on when and how to receive payment.
Although choosing to compensate yourself as an employee or member are the most common options, the third option is to be hired as an independent contractor, or as an outside self-represented entity that was hired by the business to complete certain project-based tasks. In opting to pay yourself as an independent contractor, you’d have to pay yourself within specific tax criteria.
The benefits of paying yourself as an LLC
You might be asking — what are the benefits of each option? Let’s take a look at the nuts and bolts of paying yourself in your LLC. Your decision will primarily rest on the size of your business, profit margin, and your financial needs within your personal budget.
1. Paying yourself as an employee
The primary benefit of business owners being paid as an employee is having a regular income.
If a predictable income is imperative for your personal budget, then being paid as an employee may be the most advantageous option. It’s important to do your research and pay yourself a wage that is realistic for your industry, workload, and location (if you own a brick and mortar business).
Although the IRS considers employee wages a business expense, they will only recognize salaries that meet your industry’s taxable criteria. For example, a $150,000 salary for a soap-making business won’t be realistic. (Hey, we’re cheering you on and hope you get there! Just know that the IRS may not back those wages.)
As an employee of your LLC, you will be presented with a W-2 from your business. The LLC will withhold employee and income taxes from each paycheck. You will file with the IRS and pay taxes on the wages that you earned.
2. Paying yourself as a member of an LLC
Being paid as a member generally means that you are going to be paid at the end of the year with a portion of the LLC profits for that fiscal year. Each member gets their percentage of the profits in one lump sum.
There is the option to draw from the net profits each month during the course of the year. If you anticipate the end of year profit is $36,000, then you would put in a draw to receive $3,000 each month. You would be eligible for any end of year profit that is over your $36,000. For example, if you received $36,000 over the course of the year and the profit ended up being $40,000 then you could pay yourself the $4,000 difference.
If you’re the only member of your LLC then you will file your profits and losses with the IRS on your personal tax return. You’ll pay taxes on all of your distributions you paid yourself throughout the year. Multiple member businesses pay taxes on their share of the profits. The LLC then files with the IRS how much each member is paid.
3. Paying yourself as an independent contractor
You may choose to hire yourself as an independent contractor for your LLC if you have a particular skill set that your business needs often. If you are especially good at videography, then by all means, hire yourself to film and edit all of the social media videos for your LLC. Independent contractor pay allows your business the opportunity to stay on budget for projects rather than hire via a third party.
As an independent contractor, you will need to pay self-employment taxes on your wages. You will file a W-9 with the LLC. The LLC will be responsible for IRS Form 1099-MISC during tax season.