Stepping into the realm of entrepreneurship often comes with a barrage of questions, one of which is: Can you be an employee of your own LLC? This query treads the lines of legal structures, taxation nuances, and business operations. It’s not just about titles or roles, but also about understanding the financial and legal implications that come with wearing multiple hats in your business.
In this guide, we’ll unravel the complexities of this topic, shedding light on the feasibility and implications of serving as both owner and employee within your LLC.
“Can you be an employee of your own LLC?” The simple answer is YES. You can be an employee of your own business. So, as an LLC owner, you can pay yourself as an employee if you meet IRS criteria for reasonable salary compensation. Your LLC’s tax status determines options like payroll deductions and eligibility for fringe benefits. Overall, becoming an official employee of your own LLC requires following regulations but can offer significant advantages.
Being able to draw a salary as an employee of your own limited liability company (LLC) provides valuable benefits, but isn’t always straightforward. The ability to pay yourself as an employee depends on your LLC’s tax status and compliance with IRS rules.
When starting an LLC, most owners aim to take profits out of the business. However, taking distributions or draws doesn’t provide the same advantages as payroll. Paying yourself an employee salary allows you to receive guaranteed wages, while gaining eligibility for unemployment, workers’ comp, and fringe benefits.
How LLC Tax Status Affects Ability to Draw Salary
Your LLC’s tax status plays a major role in whether you can pay yourself as an employee. LLCs have flexibility in choosing how they are taxed. Depending on the election, an LLC owner may or may not be able to officially draw a salary from their own company.
Sole Proprietorships and Partnerships
For LLCs taxed as sole proprietorships or partnerships, members cannot technically be employees. However, you can still pay yourself from profits as a guaranteed payment, similar to a salary. This income is subject to self-employment tax. Your LLC itself does not withhold taxes or report wages on a W-2 form.
If your LLC elects to be taxed as a C corporation, owners who work for the company can be employees. The LLC handles payroll, withholding taxes from your salary. You must receive W-2 forms for income, instead of simply taking draws.
S corporations allow owners to be employees and draw salaries. Wages are subject to payroll taxes. However, the IRS requires “reasonable compensation” to prevent misclassifying distributions as salaries. Factors like your experience, location, and industry standards determine reasonable pay.
Major Benefits of Paying Yourself as an LLC Employee
Beyond guaranteed income, becoming an official employee of your own LLC provides additional advantages. As an LLC owner-employee, you can realize payroll tax savings, establish retirement plans, qualify for unemployment and workers’ compensation, and gain eligibility for tax-free fringe benefits.
Paying yourself through payroll unlocks valuable perks not available when simply taking distributions as a member. So, beyond guaranteed income, becoming an official employee of your own LLC provides additional advantages such as:
Payroll Tax Savings
As an S corp employee, you only pay Social Security and Medicare taxes on your salary, not total business profits. This can equal over 15% savings on a portion of your earnings. C corporations provide payroll tax savings as well.
Ability to Provide Retirement Plans
Only employees can participate in certain retirement accounts like 401(k)s. Paying yourself through payroll allows you to establish tax-advantaged retirement savings options.
Unemployment and Workers’ Comp Eligibility
In most states, you must pay into unemployment insurance and workers’ compensation funds to be eligible for benefits. Drawing an employee salary enables you to qualify.
Tax-Free Fringe Benefits
As an employee, you can provide yourself benefits like health insurance tax-free. LLC members normally pay taxes on any benefits.
Paying yourself as an employee unlocks valuable perks and options. For LLC owners who are active in the business, drawing a salary can optimize tax and financial planning.
How to Draw a Salary from Your LLC
If your LLC structure allows paying yourself as an employee, you’ll need to set up payroll processing to receive wages. The key steps include obtaining an EIN, choosing your pay rate and schedule, finding a payroll provider, paying applicable employment taxes, and filing required forms. While it takes some initial setup, running payroll for yourself as an LLC owner-employee provides major tax and financial benefits. Here are key steps:
1. Obtain an EIN from the IRS
An Employer Identification Number (EIN) serves as a taxpayer ID for your business. It’s required for processing payroll and withholding taxes.
2. Set Your Pay Rate and Schedule
Choose how often you’ll be paid – weekly, biweekly, etc. Set your salary based on industry standards and revenue to qualify as reasonable compensation.
3. Find a Payroll Provider
Using payroll software or services greatly simplifies paying yourself. They automatically handle tax withholding, filings, and direct deposits.
4. Pay Applicable Employment Taxes
In addition to income tax, your LLC must pay Social Security, Medicare, federal and state unemployment taxes on your wages.
5. File Required Tax Forms
You’ll receive Form W-2 from your business documenting wages paid. Your LLC must submit payroll tax returns like Form 941 and applicable state forms.
While it takes some setup, paying yourself as an employee provides major financial advantages over taking owner draws. Just be sure your salary meets “reasonable” standards.
Legal Considerations for LLC Owners as Employees
To avoid IRS scrutiny when paying yourself as an LLC employee, consult accounting and legal professionals to ensure compliance. You must draw reasonable compensation aligned with your contributions, avoid imbalanced salaries between co-owners, and properly apportion wages if the LLC isn’t your sole income source. Proper documentation also helps justify your payroll decisions if questioned. Some key factors include:
Any salary you draw must be justified based on your skills, location, hours, and typical pay in your industry. Unreasonably high pay can be reclassified as distributions.
Matching Compensation to Work Performed
Your wages should align with your contributions as an employee. You can’t take a full salary if you aren’t actively engaged in the LLC’s business.
Paying Co-Owners Appropriately
If you co-own the LLC, each owner’s compensation should accurately reflect their position and involvement. Imbalanced salaries can raise red flags.
If the LLC isn’t your sole income source, your salary should be proportional to the time spent working in the business.
Consulting professionals helps ensure your payroll structure is sound and optimized for savings. It’s also wise to document your compensation decision-making in case of an audit.
LLC Employee Payroll Process Explained
Running payroll for yourself as an LLC owner-employee involves withholding taxes, paying employer payroll taxes, reporting and submitting payments, and distributing net pay. While complex, using payroll software or services simplifies the process of withholding income and employment taxes, calculating deductions, filing returns, and paying yourself your net wages. Here is an overview of the process:
Step 1: Withhold Social Security and Medicare Taxes
Known collectively as Federal Insurance Contributions Act (FICA) taxes, the IRS requires employers to withhold 7.65% from employees’ wages for these programs.
Step 2: Withhold Federal Income Taxes
Your salary is subject to federal income tax based on your filing status and deductions. IRS Publication 15-T provides exact withholding amounts.
Step 3: Adhere to State and Local Income Tax Requirements
States have varying income tax rates, withholding rules, and forms. Research obligations in the state(s) where your LLC operates and you live.
Step 4: Pay Employer Portion of Payroll Taxes
On top of deducting FICA taxes from your paycheck, your LLC must contribute and pay 7.65% of your wages to the programs as your employer.
Step 5: Pay Federal and State Unemployment Taxes
These taxes fund unemployment insurance benefits employees can receive if laid off. Rates vary by state.
Step 6: Report and Submit Payroll Taxes
Form 941 reports payroll taxes to the IRS quarterly. You must also file returns for state unemployment and withholding taxes.
Step 7: Distribute Net Pay
After taxes and deductions, payroll services or accounting software can automatically deposit your net salary into your bank account.
While complex, payroll processors greatly simplify paying yourself as an LLC employee. They automatically handle calculations, filings, and payments.
Takeaway: Being an LLC Employee Provides Benefits But Has Complexities
As an LLC owner, paying yourself with guaranteed wages through payroll unlocks advantages traditional profit distributions don’t offer. However, you must follow compensation rules and tax protocols to avoid IRS penalties or reclassification of wages as distributions.
Consulting tax professionals helps ensure you setup payroll appropriately based on your situation. While being an official employee of your own LLC requires extra planning, the benefits often make the additional effort well worth it.
5 Key Things to Know About Paying Yourself as an LLC Employee
- Your LLC must be taxed as an S corp, C corp, or partnership to make owners into employees.
- Paying yourself a reasonable salary saves on payroll taxes compared to taking distributions.
- Drawing a wage provides eligibility for unemployment, workers’ comp, 401(k) plans, and tax-free benefits.
- Be sure to follow all payroll tax withholding, payment, and filing requirements.
- Document your compensation decision process in case the IRS questions if wages are reasonable.
Frequently Asked Questions (FAQs)
Can I be an employee and owner of my LLC?
Yes, if your LLC is taxed as an S corp or C corp, you as the owner can also be an employee receiving wages. This allows you to gain advantages like payroll tax savings that member distributions don’t provide.
What taxes do I pay as an LLC employee?
As an employee, your wages are subject to income tax withholding, Social Security tax, Medicare tax, and federal and state unemployment taxes. Your LLC employer also pays shares of these, along with workers’ comp insurance.
How should an LLC pay its owner?
Many LLCs pay owner-employees a reasonable salary plus distributions of remaining profits. The salary portion minimizes employment taxes while distributions avoid payroll taxes. This optimized structure provides a mix of wages and payouts.
Can I get unemployment if I pay myself through an LLC?
If your LLC pays state unemployment insurance taxes on your wages, you can qualify for unemployment benefits from that state if laid off or the business closes. However, you usually can’t receive unemployment based only on LLC distributions.
What is considered reasonable salary for an LLC owner?
Factors like your experience, certifications, the company’s revenue, typical pay for your role, location, and hours worked determine reasonable salary. There’s no universal rule, but your wages should be justified and comparable to market rates.
Does an LLC need to distribute profits?
LLCs aren’t required to distribute profits. Members pay taxes on profits regardless of distribution. If members rely on LLC income, retaining all profits without distributions isn’t advisable.
What forms do I need to pay myself as an LLC owner?
To pay yourself as an employee, an LLC needs an EIN and must file forms including: W-2, W-4, I-9, 940, 941, applicable state withholding and unemployment tax returns.
Can my spouse be an employee of our LLC?
For spouses co-owning an LLC, either can be an employee if operating as an S corp or C corp. Compensation must accurately reflect involvement and effort. Payroll for both may provide tax advantages in certain scenarios.
How much should an LLC owner pay themselves?
LLC owners should determine salary based on reasonable compensation standards for their role, experience, location, and revenue. Distributions can provide additional income not subject to employment taxes.
Alfie Wilson, Esq., is a legal content writer with expertise in business formation, criminal law, veterans disability, family law, DUI law, personal injury, animal welfare, and legal writing. He holds a J.D. from Emory University School of Law and has experience in appellate advocacy and regulatory matters. Alfie’s passion lies in breaking down complex legal topics for a non-lawyer audience. He currently writes for law firms and non-profits on various issues and resides in Arlington, Virginia.