Entrepreneurs choose to start their first LLC to control how much they make. Owners aren’t relying on someone else to get paid. Entrepreneurs are not dependent on superiors for their checks.
While most people are living life relying on someone else for their paycheck, successful LLC owners call the shots on how they get paid, how much they get paid, and how often they get paid.
What you make as an entrepreneur represents the fruits of all your labor in getting the business up and running in the first place, not to mention maintaining and growing it.
The question becomes:
How do I get my hands on my hard-earned cash?
Different business entities come with different ways of getting you your money. How you decide to pay yourself depends on a few key factors. The type of entity you’re operating also affects how it’s viewed by the government and what taxes you’ll end up paying.
Here are some questions this article will help you answer:
- What business entity am I operating as?
- Which payment method corresponds to that entity?
- How much should I pay myself?
- How often do I want to get paid?
- How is the money getting into my account?
The metaphorical cards are in your hands when it comes to how much you make as a business owner. The strategies you take, the choices you make, and your commitment to your company all determine how much money you’ll bring in.
“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.
How Do I Pay Myself From My LLC?
How you get paid from your LLC depends on how it’s set up and operated.
There are two categories of LLC:
Default LLCs and Specialty LLCs.
Here, in this article, we will discuss Default LLCs since it’s much more efficient to begin operations as such. Plus, it’s probably the route you’re going to take, at least initially.
You’ll learn about the different variations of LLC, examples of how the finances work, and their respective taxes.
Default LLCs include:
Single Member LLCs
Specialty LLCs include:
Default LLCs fall in the same tax category as Sole Proprietorships. Both are considered Disregarded Entities. The only real difference between the two is personal Liability Protection.
Liability Protection is the whole reason why someone chooses an LLC over a Sole Proprietorship. Besides that, Default LLCs pretty much undergo the same payout procedure as Sole Proprietorships.
Moving your money straight over to a personal bank account (as a Draw) is the norm, but LLC Owners also have an option to get paid through a Salary and Dividends. Sole Proprietors only get their money through Draws.
Some states have special laws when it comes to Owner’s Draws. This is one of many reasons why it’s important to do your due diligence and speak with business professionals, tax experts, and lawyers to make certain you aren’t missing vital information.
Keep reading for more details on how to collect your cash the Right Way.
There are Single-Member LLCs and Multi-Member LLCs. If two people run an LLC it is viewed as a Partnership. More than two and it is technically viewed as a Corporation.
LLC Owners are referred to as Members. The Members have personal liability protection. Hence the name, “Limited Liability Company”. This protection comes from the separation of personal finances from business finances. This division is the main characteristic of LLCs.
The way an LLC owner gets paid depends on different variables. Things like how many Members are involved in the LLC, how the LLC is taxed, and if there are profit sharing or other sweat equity agreements. These all play a role in how and when you get your cash.
But first, we have one pressing question:
What is an LLC, really?
The money coming into your LLC is divided based on agreed-upon percentages set for each member of your company. Your LLC’s profits become personal income after moving the money from the company and placing it into your bank account.
Before everything gets complicated we can break this process down to just four words.
Cut yourself a check.
When you are following the default taxation method for LLC’s you have to record whatever you end up paying yourself. Write it down and log it in your business’s accounting records.
To clarify things for future reference you should log these payments to yourself as ‘Personal Withdrawals’ or ‘Membership Distributions’.
If you are operating a Single-Member LLC you decide how much you want to withdraw from net profits after they’ve been taxed. This is an owner’s “Draw”.
Alternatively, if you’re a part of a Multi-Member LLC you will split profits based on percentages outlined in your LLC’s Operating Agreement. Each Member’s payment is a “Distribution”.
Your Draw or Distribution is recorded on your income tax return when you file taxes individually.
The IRS taxes LLC owners in this manner by default. The whole process is called Pass-Through Taxation because your business profits get “passed-through” Income Tax before it becomes “yours”.
The reason “yours” in quotes is you still have to pay Self-Employment Tax (FICA) on what you claim as personal income. This Self-Employment Tax consists of Medicare and Social Security Tax.
God Bless America!
Just be sure not to “draw” too much money out of your LLC as it would destroy your Corporate Veil, voiding your limited liability protection.
To put it differently, always leave enough money in your business to prevent Undercapitalization. If you’re unable to maintain operations, pay debts, or fight legal battles, you could possibly lose personal assets like your house, car, even investments.
Is Pass-Through Taxation right for me?
Pass-Through Taxation is good for getting your business up and moving. When you’re starting it’s important to reinvest the majority of profits back into your business. Focus on scaling.
The more you’re investing in yourself and your business in the early stages, the better off you’ll be down the road.
Later on, when you’re making some serious money, you can always decide to switch business entities to a Specialty LLC such as an S-Corp or C-Corp.
In some cases, the Pass-Through method can be more advantageous. The cost of payroll services and accounting (which are requirements of S-Corp and C-Corp Taxation) may be more expensive than the tax benefits you would receive with an S-Corp or C-Corp setup.
How Do LLC Taxes Work?
Let’s say you recently began operations and your business is off to a good start bringing in net profits of 10,000USD annually. Nice!
All of these stacks are accounted for in your personal income tax filings. The amount you’re taxed is based on Federal Income Tax Rates as well as your State and Local Income Tax Rates.
But wait, there’s more!
You might also have Estimated and Excise Taxes depending on several criteria.
After the business’s net profits are taxed, you choose how much you want to make yours and separate it from your business.
For the sake of our example, you take 2,000USD and put it in your pocket (i.e. bank account).
You can’t do that yet.
Fortunately, there are more taxes. (I know it’s hard, but we have to be positive)
As the owner of a Single-Member LLC, you pay Self-Employment Tax on the 2,000USD.
Self-Employment Tax is two separate taxes combined under one name to make it more confusing. Self-Employment Tax is just a combination of Medicare and Social Security.
After the Self-Employment Tax, the remainder of the distribution/draw (2,000USD) is all YOURS!
So get to work and make this example seem like rookie stuff.
Single Member LLCs
In a Single-Member LLC, all the money gets split between you, your business, and the Feds.
LLC Owners are not employees and don’t get paid out the same way as employees. Owners get their money in the form of Owner’s Draws.
If you do happen to have employees you just pay them wages and count it as a business expense. (P.S. There’s a tax if you’ve got employees working for you).
The Owners of both Sole Proprietorships and Single-Member LLCs are considered the business itself. When the Owner is the business, it is referred to as a Disregarded Entity.
A Disregarded entity is a business owned by one person and is taxed through that person. Instead of the LLC paying taxes itself, the owner pays the taxes and accounts for all profits and losses on his/her personal tax return.
This means your business’s profits/losses are passed on to you and your account for them in your Personal Tax Returns. This is why the process is called “Pass-Through Taxation”.
When you file your tax return you must include your income from your Draw as well as the LLC’s profits.
The requirements for Pass-Through taxation vary from State-to-State. Yet another reason why it’s important to speak with financial advisors, lawyers, or other business professionals before making a binding decision on how you’ll get paid.
You want to make sure you are well informed so you do it right and don’t mess anything up (too badly).
Besides the default Pass-Through route, you can tax your LLC as a Corporation. With Corporation Taxation you’re getting paid through a combination of a Salary and Distributions instead of only a Draw.
The biggest reason professionals choose Corporate Taxation is the lack of Self-Employment Tax, among other tax benefits.
The benefits of this are only noticeable when your business is producing significant profits regularly. Because of this, Corporate tax isn’t so optimal for newly forming LLCs.
On top of that, going the corporate route has its drawbacks. Generally speaking, Corporate taxation is more complicated than Pass-through Taxation. It comes with other taxes, more paperwork, and maintenance requirements.
As the Owner of a Single-Member LLC, you can get taxed as a Corporation. Or, if you don’t want that, you’ll fall under the default taxation of LLCs where your company is seen as a disregarded entity.
The biggest difference between Single Member and Multi-Member LLCs:
Multi Member LLC owners agree upon each individual’s portion (or share) at the time the LLC is formed.
Just as a single-member LLC owner get Draws by default, multi-member LLC owners get paid through Distributions. Each Member receives a percentage of the business’s profits based on the Operating Agreement contract.
The cash each member receives is categorized as Personal Income. With Default LLC taxation, this money is subject to both income tax and self-employment tax, since Members are viewed as Self-Employed.
Multi-Member LLCs are set up with multiple owners or Members, as they’re called.
Who would have guessed?
But, what you might not know is Members can’t just be anybody. You don’t qualify for Multi-Member LLC status if the only other person you run the business with is your spouse.
With the division of finances between owners, it is especially important to discuss how much each member gets paid before the cash starts to roll in and tension rises.
Everybody in your company has to be in agreement and know exactly what to expect regarding how much and how often everybody gets their share.
Don’t forget that Draws/Distributions are different from the paychecks and salaries you might be used to. You’ll need to cover Social Security tax and Medicare tax personally.
Luckily, the Federal government has made it easy for you to give them your money. The IRS has combined these two taxes calling it Self-Employment Tax.
It’s a good idea to pay taxes every three months (quarterly) to stay on top of things and be more aware of your business’s financial movements.
When Do I Get My Money?
Defaut LLC Owners (both single-member and multi-member) get paid through Owner’s Draws. You also have the option of getting paid through a combination of a Salary and Dividends.
Either way, you’ll be recognized by the IRS as self-employed.
The Owner’s Draw is proportional to how much you’ve invested in the business. Drawing from your business reduces your overall share in the business since you are separating money from the business side and moving it to the personal side.
Draws are only accounted for on personal income taxes and are not taxed when taken from the company. This is why it is called Pass-Through Taxation. The taxes are “passed” from the company to you.
One thing you should remember:
Draws can NOT be categorized as business expenses.
If you’re operating a Single-Member LLC you have to take care of both your business’s taxes and your personal taxes. The whole point of an LLC is to keep them separate.
Let’s say you prefer the Salary method:
With a Salary, you’ll receive a set amount of money regularly (usually monthly). Salary income is taxed on both the Federal and State Levels.
Unlike Draws, Salaries CAN be categorized as business expenses.
You’ll get paid once you’ve come up with a solid, realistic number to pay yourself. Figuring out this amount is discussed in the next section.
First, you have to deduct all your business expenses and get your financial records up to date. Only then can you take your reasonable payment from the remaining profits.
Everything that doesn’t go to the Fed’s or become Personal should stay in your company’s account. It is extremely important to reinvest a significant portion of profits back into your business.
This is especially true in the beginning stages of the business when continuity and growth are critical to the future success of your business.
Entrepreneurs get paid in a few different ways depending on the State.
Possible pay schedules are:
Weekly, Semi-Monthly, Bimonthly, Monthly.
Every state has its payroll schedule and payment periods. So, just make sure you decide based on the options available in your State.
How Much Should I Pay Myself?
You wanna know how to get into a lot of trouble very quickly?
Cash-out your business completely and move all of it into your account.
This is not good. Don’t do this.
Instead, you crunch the numbers and figure out how much money you need to get by on.
Not want, NEED.
Regardless of payment method, you must be realistic with what you pay yourself.
It all lies in the balance.
Start paying yourself too much you might end up under-capitalizing the business you worked so hard to create, not to mention, you risk the IRS coming after you.
Pay yourself too little and you won’t be able to afford the minimum requirements of a happy, healthy, and sustainable life.
To find out what is reasonable by society’s standards (I’m not saying that you should always listen to what society has to say) you should look at what businesses are paying for job positions similar to yours.
Additionally, you should consider the following:
What is a reasonable payout based on the market you’re in?
What’s the cost of living where you live?
How much have you invested in your business?
How in-demand is whatever you’re selling?
As time goes on, you might need to downsize your lifestyle if you see your business isn’t producing what you expected it to. You shouldn’t run your business into the ground just to support a lifestyle that isn’t financially practical right now.
There is no special way to figure all this out. There isn’t one correct answer, which is part of the appeal of entrepreneurship. Rolling with the punches and making the best decisions you can now while you have the chance.
Owning a Pass-Through entity, you can pay yourself as much as you want from your portion in the company. But, there are certain things that you must consider before taking all of the money from your business.
Remember the business’s operating costs/expenses, outstanding debts, annual (and quarterly) taxes, and setting up a reserve of money for your business.
Once the business expenses are recorded and deducted from the total business revenue what you’re left with is net profit. With the net profit, you crunch the numbers and figure out how much to set aside for taxes.
After taxes are dealt with, you’ll calculate what remaining profits will go to monthly payments for things like loans, mortgages, etc.
Then you will decide how much money will be reinvested in your company or set aside as emergency reserves.
Finally, after all of this, you can begin thinking about how much you want to become personal.
You shouldn’t move all that remains into your personal account, only what you NEED. To figure out how much this is, look no further than your personal budget.
Your personal budget includes goods and services you pay for on a daily, monthly, and yearly basis in addition to all of your savings and investments (BUY BITCOIN).
Cost-of-living expenses include things like food, rent/mortgage, utilities, education, insurance and healthcare, credit card payments, car payments, internet and phone, memberships, restaurants, and the list goes on. You get the idea.
When figuring out your budget you should first calculate non-discretionary expenses before your discretionary expenses.
Non-discretionary expenses are non-negotiable. Things you must have to maintain quality of life. These are usually recurring, but they also include uncommon, unpredictable expenses like emergency medical bills.
Discretionary expenses are optional expenses that improve quality of life. These are the fun, fancy, extras.
Hopefully, with enough profit remaining after all of the business expenses, payments, and reinvesting are covered, you will be able to pay yourself a pretty decent amount.
On the flip side, if the remaining profits aren’t so much, you may have to re-evaluate your lifestyle choices and part ways with some of your discretionary expenses, and maybe even downsize or limit your non-discretionary expenses.
Cut that check!
Now that you know your payment schedule and how much you are looking to take in, your next step is choosing whether you want a Lambo or a Ferrari.
You’ll choose between getting a direct transfer deposit into your bank account, or by writing a check to yourself.
Oh, and before we forget…