A Limited Liability Company “LLC” owner payments or “payroll” has different requirements than other types of business entities. Many small business owners choose to operate their companies under the LLC structure, and with good reason. However, there can still be some murkiness around important tax and payroll issues. Learn answers to top questions, so you can handle it correctly.
WHAT IS AN LLC?
A Limited Liability Company (LLC) is a hybrid entity that combines the liability protection of a corporation with the benefit of pass-through taxation of a partnership or sole proprietorship when it is initially formed. The owners/investors of an LLC are called members. Depending on state requirements, the members most often enter into an operating agreement governing the management and conduct of the LLC’s business. The LLC is also required to maintain a current list of the full name and last known business or residence address of each member together with the contribution and the owners share in profits and losses.
There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner. A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information.
Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a partnership or sole proprietorship initially unless it is registered as (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a C-Corporation or S-Corporation. For purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity and a sole proprietorship unless the same 8832 is filed with a similar election.
HOW DO LLC OWNERS GET COMPENSATED?
Most often, LLC payroll guidelines dictate that owners cannot be regarded as employees of the company if they are taxed as a partnership or sole proprietorship. As a result, they are not eligible to receive compensation in the form of wages and salaries. Instead, singular owners of LLCs are treated as sole proprietors for tax purposes, and multi-member owners are treated as partners in a partnership. In order to be paid by the business, LLC members take money out of their share of the company’s profits. Additionally, with a partnership, an actively working partner in a partnership might receive (a “Guaranteed Payment”).
If an LLC elects to be taxed as a C-Corporation or S-Corporation, members may then be considered employees and can therefore receive wages, salaries, dividends, and other pass-through income on their personal tax returns.
A brief overview of how owners/members of an LLC get paid:
Single-Member LLC: A single-member LLC owner withdraws money by writing themselves a business check or transferring money from the LLC bank account to their own personal account.
Multi-Member LLC: Each member has a capital account—a log of shareable information tracking their membership and financial activities within the LLC. When they need to be paid, they can draw from the LLC, which is accounted for in the capital account, via business checks written out to the member. And, if appropriate under the partnership, may also receive a Guaranteed Payment.
Because there are several complexities regarding LLC’s and how their owners are paid and therefor taxed, it is essential to consult tax and accounting experts to understand your options and make sure everything is accurate for federal and state tax rules and operating requirements.
HOW ARE INCOME TAXES HANDLED IN LLC PAYROLL?
One of the most appealing features of owning an LLC business is the fact that the company itself does may not pay taxes, unless they elect to be a C-Corporation. Instead, the profits and losses are distributed amongst its members, who then must report income or losses on their own personal income tax returns. When an LLC is established as a partnership, members decide if all owners will divide the company’s profits evenly, based on ownership percentage, or some other agreed upon standard. Then each member is taxed accordingly.
It's important to remember that as a partnership or sole proprietorship, any funds that an owner withdraws from the LLC is not considered a paycheck. Therefore, no federal, state, or FICA taxes are withheld from those withdrawals. It’s advised that each LLC member makes estimated tax payments every quarter to cover taxes due on their share of the LLC’s profits, which are taxed the same regardless of whether they stay in the company’s account or are dispersed as a withdrawal to members.
TRUST THE EXPERTS
Payroll Vault has been in the business of assisting small and medium-sized corporations in various fields, including LLC payroll, since 2008. Handling these issues in-house can be challenging and time-consuming for even the most savvy entrepreneurs, so Payroll Vault provides an outsource payroll solution to walk you through the process.
Learn more about how Payroll Vault - Western Michigan can serve your business and get a quote today.