As a single-member LLC owner, you can access your business profits through both salary and distributions.
Taking a “reasonable” salary subject to payroll taxes ensures Social Security and Medicare contributions, while distributions allow you to withdraw remaining profits at a lower tax rate (potentially avoiding them altogether if within your basis).
That sounds amazing! There has to be a catch, right?
Can an LLC Owner Forfeit a Salary and Take ONLY Tax-Free Distributions?
Taking no salary might raise IRS red flags. It’s crucial to maintain accurate records and consult a tax advisor to determine your basis and optimize your salary/distribution mix for tax efficiency and future financial security.
While taking all your income as distributions from your LLC sounds appealing, it’s important to understand the nuances and potential implications before implementing this strategy.
Considering taking all income as distributions in an LLC?
So, you get your LLC for your business, you pick your company name, assign your registered agent or assume the role yourself, and now you’re configuring your pay structure to maximize deductions on taxes while reducing legal liability from the IRS.
Here’s a breakdown of how it works and the factors to consider:
- Pass-through taxation: As a single-member LLC, your business profits and losses flow through to your personal tax return, avoiding double taxation. You are subject to self-employment taxes on the entire amount.
- Distribution vs. salary: Instead of paying yourself a salary, you can take all your income from the LLC as “owner’s draw” or “distributions.” This means transferring money from the business bank account to your personal account. This is not necessarily recommended, though it’s a possibility.
- Taxation of distributions: Distributions generally aren’t taxable up to the amount of your “basis” in the LLC. Your basis is the total amount of money and assets you’ve contributed to the business. Once you’ve withdrawn your entire basis, any further distributions become taxable income at your personal income tax rate.
- Reasonable compensation: The IRS expects LLC owners to pay themselves a “reasonable salary” reflecting the services they provide to the business. While there’s no strict formula, taking no salary might raise red flags, potentially leading to tax audits and reclassification of distributions as wages subject to payroll taxes and penalties.
Factors to consider before taking all income as distributions:
- Tax implications: Consult a tax advisor to calculate your specific basis and understand the potential tax consequences of taking all income as distributions. This ensures you don’t withdraw more than your basis and incur unexpected tax liabilities.
- Retirement benefits: Taking no salary means you won’t contribute to Social Security or Medicare through payroll taxes, impacting your future retirement benefits. Consider alternative retirement savings options.
- Health insurance: You’ll be responsible for securing your own health insurance coverage outside of traditional employer-sponsored plans.
- Perception: Taking no salary might appear unprofessional to business partners or potential investors.
- Combination of salary and distributions: Consider paying yourself a reasonable salary to contribute to Social Security and Medicare while taking the remaining income as distributions.
- S corporation: If you anticipate consistent high income, transitioning to an S corporation might be beneficial later as it allows you to take a salary and avoid double taxation on distributions.
Remember: Opting for all distributions is a legitimate strategy, but it requires careful planning and tax considerations. Consult with a qualified tax advisor to understand the implications and explore alternative options that align with your long-term financial goals and business needs.