So today, we're going to talk about one of the most common questions I get from people that are forming LLCs. How to pay yourself with an LLC?
Over the past several weeks, we spent a lot of time focusing on many of the foundational elements of forming your LLC. This includes choosing the right business entity to begin with, switching from a sole proprietorship to an LLC, what you need to do to set your LLC up the right way, common mistakes people make when setting up their LLCs. All those real foundational things that you need to know about when you're starting your LLC.
All right. Let's get to it. So for some reason, a lot of business owners are really somewhat fearful of the idea of paying themselves from their business. I'm not sure I completely understand this fear, but I think it probably has something to do with the fact that you're scared about doing it wrong or incurring some tax liability that you're not going to be able to pay or something else. I suspect that's the case.
So the way you pay yourself is really going to vary in large part on the type of business that you have and the entity that you've chosen to run your business. In other words, as an LLC, it's going to be a little bit different than if you are a sole proprietorship, which is going to be a little bit different than if you're an S corporation, which is going to be a little bit different than if you are a C corporation. Does that make sense? I hope.
We are going to focus primarily on how to pay yourself if you're running a single member LLC. If you're a multi-member LLC, it's going to be a little bit different. But today, we're going to talk about a single member LLC. And we're going to talk about the two different ways that you can pay yourself as a single member LLC. And that's as a disregarded entity on the one hand or an S corporation, as far as taxing status on the other.
How to Pay Yourself in a Single Member LLC Method #1 – Write Yourself a Check
So the first method to pay yourself is if you're just a blanket garden variety vanilla single member LLC, you've not elected any type of S corporation status. And the way to do that is you basically are going to write yourself a check. We're going to talk more about that in just a minute.
How to Pay Yourself in a Single Member LLC Method #2 – Pay Yourself a Reasonable Salary
The second method is to actually pay yourself what is called a reasonable salary. And when you do that, you're actually going to withhold payroll taxes, FICA, state and federal withholding. All those types of things will be done because you're going to actually pay yourself a salary. And you're going to receive a W-2 at the end of the year, just like you would if you were an employee for any other business. So, you do this when you've made an S corporation election for your business. And that's because if you've elected to be taxed as an S corporation, you have a legal requirement to pay yourself that reasonable salary we just talked about.
So, you're probably wondering what is a reasonable salary. That's a great question. So, a reasonable salary is something that it's a term of art that was created by the IRS and is basically going to vary depending on the type of business you're in and your role in that business.
So generally speaking, what a reasonable salary is the amount of money that you would pay yourself if instead of being the owner of the business, you were actually the technician doing the work in the business. Does that make sense?
So for example, if you are a law firm like I run a law firm, it's the amount of money that I would pay myself if I were a lawyer working in a similarly sized law firm. If you are let's say an agency owner, it's the amount of money that you pay that graphic designer to do the work of designing graphics for your clients or customers. So when you would like to be taxed as an S corporation, it does get slightly more complicated and a little bit more confusing when it comes to the payroll aspects of your business. And I'm going to venture to guess, and this really isn't that much of a guess, I don't think this is that farfetched, that if you elect to be taxed as an S corporation, in all likelihood, you're going to need to go ahead and hire a bookkeeper or an accountant or a third party agency of some sort service who can help you run payroll for your business.
If you elect to be taxed as an S corporation under no circumstances, unless you have an accounting background and you know how to do these things, should you try to do payroll on your own, you will 100% I guarantee mess this up. And not only that. For 50 bucks a month, you can hire a service that's going to do all this for you. They're going to file all the forms, file your quarterly taxes, deposit the money in your account and do all these things for you. I don't know why you wouldn't do that.
Related Resource: Here is the resource we recommend for payroll. (affiliate link)
So, back to what I was saying at the beginning about paying yourself a check if you're a single member LLC. For the vast majority of you out there who operate as an LLC, you're going to be what's called a disregarded entity, which means that you have not yet elected S corporation status or C corporation status or any taxing status for that matter. For those of you that fall into this situation, you basically can pay yourself whatever you want, whenever you want, however you want from your business bank account to your personal bank account. That means you can write a check. That means that you can do an electronic transfer if your bank allows business to personal transfer. Some do, some don't. Or you can just withdraw cash and deposit in your account. The only requirement that you need to be concerned about is to make sure your LLC is properly capitalized so that you don't run the risk of violating any terms for purposes of piercing the corporate veil.
So let's touch on briefly how much you actually are going to pay yourself as the owner, operator of your single member LLC. I actually did an entirely separate video on Mike Michalowicz's Profit First system. And I highly recommend that you watch that video if you're trying to think about how much you need to actually pay yourself. But basically, here's the general idea. For a single member LLC, each month when you get revenue in, you're going to pick a couple of days, let's say the 10th and the 25th, and you're going to make target allocations. So, that might be anywhere from 30 to 50 to 60% of your revenue is going to go to your owner's pay. And you're going to take that amount, that percentage from your revenue, and you're going to transfer that into an account for owner's pay. The remainder or whatever's left is going to be divided up between profit, taxes, and expenses for the business. And you're going to have separate allocations for each of those. And you're going to transfer the money into a separate account for those categories as well.
So you're going to have four accounts, owner's pay, expenses, taxes, profit. And that's how you're going to pay yourself. If you're looking for a checklist of everything you need to do when you're first starting out with your LLC, here is the link to a checklist that you can download. This is a monster guide to starting your online business that talks about everything you need to do and think about as you're just getting started. And obviously, this is all from a legal perspective so that you can make sure that you've properly protected your online business.