As an active owner-operator of an LLC, you have the option of paying yourself wages as an employee of the LLC or simply paying yourself profits as a member of the LLC. The LLC generally pays wages on a regular basis as the employee performs the work, while the LLC does not distribute profits to members until the end of the year. Members can, however, pull periodic draws from the LLC. A draw is basically an early withdrawal of anticipated year-end profits.
Any LLC member who is actively involved in the business of the LLC is eligible for wage payments as an employee of the LLC. For instance, if you are the owner of an LLC that provides marketing services to your clients, and you are the person who actually manages client relationships and implements marketing strategies, you are an active member of the LLC and can set yourself up as an employee. On the other hand, if you are a member solely because you have invested some cash into the LLC, but you are not involved in any of the actual business of the LLC, then you are not an employee, and you cannot receive wage payments. A member of an LLC can also receive compensation as an independent contractor of the LLC, although there is typically little value in structuring member compensation this way.
LLC members always have the option to receive compensation in the form of year-end profit distributions. Each member has a percentage interest in, or a percentage of ownership of, the LLC, generally referred to as the member's capital account. Profits typically pass through the LLC to the various members based on their percentage interest. For example, if you who own 25 percent of the LLC, then you will probably receive 25 percent of year-end profits. Similarly, if you own 100 percent of the LLC, then you are entitled to 100 percent of the profits.
LLC members who don't want to receive wage compensation as employees of the LLC may still want to receive periodic payments throughout the year, rather than waiting until the final distribution of profits at the end of the year. As an LLC member, each time you recieve a draw during the year, your capital account decreases by the amount of the draw. Then, at the end of the year, your capital account goes back up when profits are accounted to you. In very simple terms, a draw is an advance payment of expected year-end profits.
The LLC must file the correct tax forms and keep the correct accounting records throughout the year. Any member who will be paid as an employee of the LLC must file an IRS Form W-4 to calculate the amount of payroll tax withholding from each paycheck. The LLC then pays the member-employee as a W-2 employee of the LLC. If you are going to pay yourself as an independent contractor, then you need to file an IRS Form W-9 with the LLC, and then the LLC needs to file an IRS Form 1099-MISC at the end of the year. Finally, if you will receive draws during the year, the appropriate accounting procedures need to be in place to keep track of all the draws, to estimate year-end profits and to track your capital account. This can all be complicated and sometimes requires the assistance of an experienced accountant.
When you pay yourself as an employee of the LLC, the LLC must withhold income and employment taxes from your pay and also pay the employer portion of employment taxes on your wages. Alternatively, if you pay yourself as an independent contractor, or solely in your capacity as a member of the LLC, then the LLC does not have to pay employment taxes nor does it have to withhold income or employment taxes from your wages. Instead, you will have to pay self-employment taxes, on your personal income tax return, for all of your payments from the LLC.