Under the federal tax code, an LLC with more than one member is taxed as a partnership, though the individual owners of the business are still called members. The income of the LLC is taxed on the individual returns of its members, so in at least some cases paying salaries to the members would be something of a shell game that merely shifts income from one category to another without significant benefit. The IRS does not recognize the right of members or partners to receive salaries for services provided by a partner in the official capacity of a partner.
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Capacity as Partner
The IRS deems services that are ongoing and integral to the partnership to have been provided in the capacity of a partner. For such services, the partner receives a share of the annual income or deduction for losses generated by the partnership, but not a salary. Analogously, the amount distributed to an LLC member in accordance with the operating agreement is reported on the member’s individual tax return as income from business on Schedule C or supplemental income on Schedule E depending on the nature of the business. A partner or member of an LLC taxed as a partnership must pay self-employment tax on the income derived from business.
If, however, a partner provides services other than in his official capacity as partner, he can be compensated for those services in the form of guaranteed payments. According to the IRS, the partnership can deduct these payments from its income, which reduces the amount to be distributed to the individual members as profit. But the business must make the guaranteed payments without regard to the annual profit or loss of the business. The partner reports these payments as ordinary income and pays self-employment tax on them. Repayment for allowing the partnership use of capital qualifies as a service for which guaranteed payments can be made.
A member of an LLC taxed as a partnership should receive a Schedule K-1 from the business annually. On this form, the LLC reports the member’s share of the company’s profit or loss. Schedule K does not have a line for salary. Instead, the form has lines for guaranteed payments, business income, rental income, royalties, dividends and interest. Line 11, for “other income (loss),” is not intended for regular salary but to reflect transactions such as debt forgiveness, theft, mining costs and other situations that will alter the member’s tax basis.
Single Member LLCs
All of the profit, losses and deductions of a single-member LLC are taxed to the member’s personal return, and, like partners, sole proprietors must pay self-employment tax on this income. Though a sole proprietor can technically call payments received from the company a “salary,” there is no impact on her taxes. The deduction to the LLCs income is offset by an equal increase in the member’s income, and the taxable amount remains the same. Thus, there is no equivalent of guaranteed payments for single-member LLCs.
References & Resources
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