How the members of a limited liability company (LLC) are compensated for their services and how they are taxed depends on whether it is a single-member or multi-member LLC, how the LLC elects to be treated for tax purposes, and on what the members of the LLC agree.
As pointed out by the IRS, LLCs are entities created by state law. The IRS treats a single member LLC as a disregarded entity unless it elects to be taxed as a corporation. As a disregarded entity, a single-member LLC is treated as a sole proprietorship and the owner would report the income and expenses from the business of the LLC on Schedule C, E, or F, depending on the LLC’s business. The net income would be subject to federal income tax at the individual’s tax rates and could also be subject to self-employment tax, which is the equivalent of Social Security and Medicare taxes.
An LLC with two or more members would be treated as a partnership for tax purposes, unless the LLC elects to be treated as a corporation. If no election is made, the LLC could not pay its members a salary. But it could make guaranteed payments to the members for their services. The guaranteed payments would reduce the net profits in the LLC to be passed through to the members. As indicated by Laura A. Collins in Entrepreneur, the members who receive guaranteed payments would be subject to self-employment tax on those payments and would generally have to make estimated income tax payments.
LLCs that elect to be treated as corporations could pay the members a salary. The salaries would be a tax-deductible expense for the LLC provided the employment relationship meets IRS requirements, as pointed out by Jeff Franco on Legal Zoom. And the salaries would be taxable income to the members. Additional distributions could be made from the LLC to the members in the form of dividends, which would be taxable income for the members. The LLC treated as a corporation would have to file a corporate income tax return and pay taxes at the corporate rate on its net income.
An LLC that elects to be treated as an S corporation could also pay the members a salary. The salaries would be a tax-deductible expense for the LLC and would be taxable income for the individual members.
An S corporation is treated like a partnership in that the income and expenses are passed through to the members. The members would be subject to income tax on their share of the LLC’s net profits, whether or not they are distributed. But they would not be subject to self-employment tax on distributions of net profits.
But, as pointed out in a response by Leonora Chu to a question on CNN Money and by the IRS, an S corporation that pays out only distributions and no salaries could be challenged by the IRS. For that reason, LLCs that file as S corporations often pay their members salaries according to an industry standard amount.
It should be noted that an LLC could have employees who are not members. These employees would be subject to the normal payroll requirements. FICA taxes and federal and state income taxes would have to be withheld from the employees’ salaries and wages, unemployment taxes would generally need to be paid, payroll tax returns would have to be filed, and W-2s would have to be issued for the employees at year-end.
Sources:
Lenora Chu, How to cut the tax bill on your self-employment salary, CNN Money
Jeff Franco, Can LLC Members Take a Salary? Legal Zoom
Laura A. Collins, Salary Payments in an LLC, Entrepreneur
S Corporation Employees, Shareholders and Corporate Officers, IRS
