While choosing the best entity type for your startup is one of the first steps in setting up a business, there is also the issue of your compensation. For example, if you choose to incorporate your startup as an LLC (Limited Liability Company), one of the biggest concerns is usually how to pay yourself.
Unfortunately, it is not as easy as it is when running a sole proprietorship. The rules of paying yourself in an LLC might vary between jurisdictions. However, common factors help one determine how they can pay themselves as a startup owner.
The type of LLC
One of the issues to consider is the type of LLC your business is.
If you are a sole proprietor who registered an LLC for liability purposes, your startup is a single-member LLC. It is a limited liability business, taxed as a sole proprietor business. Profits and losses pass through your individual taxes. To pay yourself, you can withdraw money from the company as a payment to yourself.
With that in mind, you must always keep records of money you draw from the business as a payment to yourself. Failure to maintain proper records could lead to run-ins with your country’s tax body. The best way to do this for adequate recordkeeping is by writing yourself checks or through bank transfers. Apart from having a paper trail for audit and tax reasons, it also ensures that you keep your personal and business finances separate.
On the other hand, if your startup has several founders, you can treat it as a corporation or a partnership. With the latter, you can pay yourself with a draw, just like with a sole proprietorship. Remember that profits and losses in partnerships pass through the different partner’s individual tax records.
You have to pay yourself as an employee, unlike the first two options where you can pay yourself through a draw, a corporation LLC with a C or S corporation. That means you will receive a salary like any other employee would in your business. With this method, you have to withhold employee taxes as the employer and remit to the tax body. As an employee, your work is to file the tax returns at the end of the year.
Additionally, startup founders with the corporation can also earn through dividends. The percentage of the money you take as dividends will depend on your startup’s articles of incorporation. In most jurisdictions, you still have to pay income tax on the dividends you earn. However, income from dividends is usually lower than what you pay on your employee tax as it is not subject to payroll taxes.
How much should you pay yourself as an LLC owner?
Whichever method you opt for, you are allowed to earn from your startup. However, ensure the sum you earn is reasonable compensation and always backed by proof, like money transfers and checks. This is ideal for startups with corporations because the taxes do not pass through your personal income taxes like a partnership or sole proprietorship.
How much is reasonable pay? Unfortunately, there is no exact figure of how much compensation you should get to make it reasonable. One way to figure out what’s reasonable is to compare the industry pay ranges in your area. Alternatively, you can calculate your annual personal expenses and have a remuneration that meets these expenses.
We recommend working with a professional, like a certified accountant. It ensures that you do not have numbers as your compensation that raise questions with the tax body. They will also help you ensure the taxes for your startup are handled well in the future.