Can I Pay Myself As an Employee In a Multi-Member LLC?
There are two ways you can be compensated in a multi-member limited liability company (LLC) for your work as a member manager, as owners actively involved in running the business are called. But to be paid as an actual employee, the members need to agree on changing the tax classification from the LLC's default status.
Sharing Profits
The Internal Revenue Service (IRS) does not recognize an LLC for income tax purposes, and instead treats a multimember LLC as as a partnership in which all of a company's income is reported on partners' personal tax returns. But unlike a partnership, members in an LLC can distribute profits in percentages disproportionate to their actual capital investment. They can decide to give you a higher percentage for your work as a member manager. But you are not a legal employee under this arrangement. IRS regulations do not allow a member to be an employee when an LLC is taxed as a partnership.
Advantages Under Default
You still receive compensation for your work that can be equal to the amount you would receive as a wage, but the LLC faces much less paperwork and filing requirements by accepting the default status. You also have the flexibility to adjust profit distributions based on the company's actual income.
Disadvantages Under Default
As a member manager, you must pay self-employment tax on your entire share of profits. The self-employment tax covers Social Security and Medicare contributions, and is equal to the contributions paid by an employee and an employer in payroll withholdings.
Becoming an Employee
A multi-member LLC can elect to change its tax classification from a partnership to a corporation. Under this regulation, member managers must be paid a "reasonable wage" based on the industry in which your company operates. Your wage and your company's share of employment taxes would be a business expense deducted from the LLC's gross income.
Advantages as an Employee
You avoid self-employment tax, but the real advantage comes if your share of profit would be higher than industry standards. When taxed as a corporation, you can receive a profit share separate from your wage that is considered "passive income." That income is not subject to self-employment tax, which can result in significant tax savings.
Disadvantages to the LLC
The LLC has more complex state filing requirements as a corporation, and more complex tax returns. The complexity may require the expense of an accountant. And if the IRS decides your wage doesn't meet industry standards, it can impose an SE tax on your profit share as well. Generally, you shouldn't choose to switch the LLC's tax classification to corporate status until you're confident profits will continue to exceed the amount paid in wages. When an LLC elects to change its classification, it can't change back for five years, except for an election made at the time the company was formed.
Tags: member manager, your work, change classification, classification from, default status