Deducting a Salary for a Single-Owner LLC

By Larissa Bodniowycz, J.D.

Deducting a Salary for a Single-Owner LLC

By Larissa Bodniowycz, J.D.

One of the advantages of forming a limited liability company (LLC) is having the flexibility to choose how your business is taxed. A single-member, or single-owner, LLC can choose to be taxed as a sole proprietorship or as a corporation. The way your single-member LLC elects to be taxed affects whether you can pay salaries and how you deduct them from federal income taxes.

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Salaries Paid to LLC Members Under Default Tax Rules

By default, a single-member LLC is a disregarded entity taxed like a sole proprietorship. A disregarded entity is a business entity considered one and the same as its owner for tax purposes. This means that if you are the single member of your LLC, you report your LLC's income and loss on your personal tax return, and you have to pay self-employment tax.

In this default tax situation, an LLC owner generally cannot pay themselves a salary. Instead, they can take money from the LLC's earnings throughout the year as LLC owner draws. A draw is not considered a deductible salary by the IRS, and you cannot deduct it from the LLC's income for tax purposes. However, it also is not taxed a second time as personal income to the owner. For example, if your single-member LLC earns $40,000 profit during a tax year and you withdraw $5,000 throughout the year as draws, you report the full $40,000 profit of the LLC once on your personal income tax return.

Salaries Paid to Members in LLCs Electing Corporate Taxation

A single-member LLC does not have to be taxed as a sole proprietorship. It can elect to be taxed as a corporation by completing and submitting an Entity Classification Election (Form 8832) to the IRS. A single-member LLC that elects corporate taxation can hire its owner as an employee and pay the owner a reasonable salary. The LLC can deduct this salary on its tax return. A salary paid to an owner is deducted by listing the amount paid as salary during the tax year in the Salaries and Wages section of the U.S. Corporation Income Tax Return (Form 1120).

A single-member LLC can also distribute portions of its profits to the LLC owner throughout the year. These payments, called distributions, are unlike salaries and cannot be deducted from the LLC's taxable income.

For example, if your LLC earns $100,000 in profits during a tax year and you receive a salary of $60,000, which is reasonable for your position, the LLC can deduct the $60,000 from its taxable income. You, however, must report the $60,000 on your personal income tax return. If you received the $60,000 as distributions, the LLC cannot deduct it.

Salaries Paid to Non-Members

LLCs are free to pay salaries to non-members. These salaries are always deductible from the LLC's income for tax purposes. If your LLC is taxed as a sole-proprietorship, you deduct the salaries as expenses on Profit or Loss From Business (Sole Proprietorship) (Form 1040, Schedule C). If your LLC is taxed as a corporation, you deduct the salaries paid by adding all of them up and listing the total amount in the Salaries and Wages section of the U.S. Corporation Income Tax Return (Form 1120).

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