The members who hold an ownership interest in the LLC have the right to actively participate in managing the business in all jurisdictions. However, the operating agreement of the LLC may place restrictions on the authority of each member or enhance it by vesting full management authority with specific members. If the LLC designates management roles to some members, the LLC may provide them with salaries that are unavailable to other members. In contrast, where all members equally participate in LLC operations by virtue of their ownership interest, no employment compensation is allowed. Resulting payments from the LLC to its members will be classified as profit distributions.
Some LLCs will draft an operating agreement that requires non-member employees to hold all management positions. In this case, the members retain their authority to vote on the selection of employees, to oversee their activities and to make decisions that fundamentally change the business. The manager is entitled to receive a salary for his services as any other employee. For accounting purposes, these salaries are one of many operating expenses of the business. Frequently, the operating agreement will place more authority restrictions on employees and limit their ability to bind the LLC to transactions that are made in the ordinary course of business.
The Internal Revenue Service allows the LLC to reduce taxable income for the reasonable salaries it pays to employees in exchange for services. This deduction extends to salaries the LLC pays to members who hold special management designations. The IRS has authority to disallow a portion of the salary deduction if it is excessive. In making this determination, it considers factors such as the complexity and level of responsibility the position requires, the employee’s salary history, the cost of living in the local geographic area, the amount of hours the employee dedicates to the business and the volume of business the employee handles.
The federal tax law also allows the LLC a tax deduction for cash or property bonuses it issues to an employee beyond the normal salary. These payments must also be reasonable in relation to the employee’s salary. The IRS does not apply a particular quantitative limitation, but makes an evaluation based on all facts and circumstances. For example, an employee’s salary may be lower than her annual bonus; however, this may be perfectly reasonable if you consistently tie the bonus amount to the level of sales the employee is responsible for. The IRS will assess the bonus with heightened scrutiny if the member receives a substantial bonus that other employees do not receive.