How to pay yourself from an LLC: draws, guaranteed payments and salary explained

The first time an LLC earns real money, the obvious question follows: how do I pay myself? The answer surprises a lot of owners. In most LLCs, you don't pay yourself a salary at all. You take money out as a "draw," and the tax is worked out on the business's profit, not on what you took.

How it works depends entirely on how your LLC is taxed. The same LLC can pay its owner in different ways depending on whether it's taxed as a sole proprietorship, a partnership or a corporation. This guide covers each one, with the mistakes that cost owners money.

First, how is your LLC taxed?

An LLC is a state legal structure. For federal tax, the IRS treats it in one of four ways, and that decides how you pay yourself.

If you haven't made an election, you're in one of the first two rows. Our comparison of LLCs, S corps and C corps explains how each is taxed.

Single-member LLC: the owner's draw

By default, the IRS treats a single-member LLC as "disregarded," meaning its income and expenses go on your personal tax return as if the business were you. So there's no salary, no payroll and no W-2. When you want money, you transfer it from the business account to your personal account and record it as an owner's draw.

The key thing to understand is that the draw isn't what's taxed. You pay income tax and self-employment tax on the LLC's profit for the year, whether you draw all of it, some of it, or none. Taking money out doesn't increase your tax. Leaving it in the business doesn't avoid tax either.

A worked example

Say your LLC's profit for the year is $90,000, and you draw $5,000 a month, $60,000 in all. The other $30,000 stays in the business account.

• You report $90,000 of business profit on your personal return, not $60,000.
• Self-employment tax applies to 92.35% of the profit at 15.3%, which comes to about $12,717.
• Income tax applies on top, at your personal rates, after deductions such as half of the self-employment tax and the qualified business income deduction.

The $30,000 you left in the business is still taxed this year. That's deliberate: it's profit, and you own it. Next year, drawing it out costs no extra tax, because it has already been taxed.

Recording draws correctly

In your books, a draw is recorded as a reduction in owner's equity, not as an expense. If your software files it under "salary" or "contractor," your profit will look smaller than it is, and your tax return will be wrong. Our guide to small business bookkeeping covers how to set up the owner's equity accounts.

Multi-member LLC: distributions and guaranteed payments

A multi-member LLC is taxed as a partnership by default. The partnership files an information return, and each partner reports their share of profit from a Schedule K-1, again whether or not it was paid out.

Partners can take money out in two ways.

• Distributions are payments of profit to partners, usually in proportion to ownership or as the operating agreement sets out.
• Guaranteed payments are payments to a partner for services or the use of capital, fixed without regard to the partnership's profit. They're the partnership version of a salary for a partner who works in the business. The partnership generally deducts them, and the partner generally pays self-employment tax on them.

One rule surprises people: partners aren't employees. The IRS says plainly that partners should not be issued a W-2 for distributions or guaranteed payments. Everything is reported on the Schedule K-1.

When one partner works full-time and another only invested money, guaranteed payments are how the working partner is paid for the work before profit is shared. Write how much, and how often, into the operating agreement. Our guide to the LLC operating agreement covers what else it should say.

LLC taxed as an S corporation: salary and distributions

Once an LLC elects S corporation status, its working owners become employees of their own company. That changes everything about how they're paid.

• A reasonable salary must be paid through payroll, with income tax, Social Security and Medicare withheld and the employer's share paid, before any other distributions. The IRS looks at your duties, experience, time and what comparable businesses pay.
• Distributions of the remaining profit are paid on top, without payroll taxes.

That split is where the tax saving of an S corporation comes from, and why the salary has to be defensible. Running payroll for yourself is simple with a provider such as Gusto, whose Simple plan costs $49 a month plus $6 per person. Our guide to when to elect S corp status works through when the saving outweighs the cost.

LLC taxed as a C corporation: salary and dividends

Rarely, an LLC elects to be taxed as a C corporation, usually for investor or long-term planning reasons. Then the company pays its own tax on profit, and owners who work in it are paid a salary through payroll. The IRS treats a corporate officer who performs services as an employee, with pay that should match their duties.

Profit paid out to owners beyond salary is generally a dividend, taxed again to the owner. That double layer of tax is why most small C corporations pay working owners a salary and keep the rest in the business.

How much to pay yourself

There's no formula, but a simple order of priorities works for most owners.

1. Cover the business first. Keep enough in the business account for the next month or two of bills, payroll and any big expense you can see coming.
2. Set aside tax. Move a share of each month's profit into a separate tax account, ready for quarterly estimated taxes. Many owners start with a quarter to a third of profit, then adjust once their accountant has seen a full year. Our guide to quarterly estimated taxes shows how to work out the payments.
3. Build a reserve. Aim for a few months of business expenses in a separate account before you take large draws.
4. Pay yourself a steady amount. A fixed monthly draw is easier to live on than irregular withdrawals, and easier to plan taxes around. Top up with an extra draw after a strong quarter.

Retirement and health insurance count too

Paying yourself isn't only about the monthly draw. Two other kinds of payment are worth setting up early, because they can lower your tax as well as look after you.

• Retirement contributions. Self-employed owners can contribute to plans designed for them, such as a SEP IRA or a solo 401(k), with limits based on your earnings from the business. For an S corporation owner, the limits are based on your salary, which is one more reason the salary level matters.
• Health insurance. Self-employed people can often deduct the health insurance premiums they pay for themselves and their family, within limits. How that works differs between a single-member LLC, a partnership and an S corporation, so ask your accountant how to set it up.

Both are easy to forget in the first year and hard to catch up on later, since contribution limits and deadlines are annual.

Mistakes that cost owners money

• Paying personal bills from the business account. Pay yourself first, then pay personal bills from your personal account. Mixing the two weakens the LLC's liability protection and muddles your books.
• Recording draws as an expense. It understates profit on paper, until the IRS or your accountant corrects it.
• Spending the tax money. Draws are cash, but the tax on the full profit arrives later. Without a separate tax account, it's easy to spend money you owe.
• Taking no salary from an S corporation. If the company has elected S corp status, distributions without a reasonable salary are exactly what the IRS challenges.
• Drawing more than the business earns. You can, for a while, from earlier profit or money you put in. Do it deliberately, and know what the business needs to keep running.

The bottom line

How you pay yourself follows from how your LLC is taxed. For most single-owner LLCs, it's a regular owner's draw, recorded correctly, with tax set aside on the whole profit. Partners add guaranteed payments for work. Once profit is steady and high enough, an S corporation election turns part of that into a salary and can lower your tax, at the cost of payroll and more paperwork. Whichever you use, keep the business and personal accounts separate, and pay yourself on purpose rather than by habit.