Work at Home

Can An LLC Member Put Himself On The Payroll? (Part I) Cliff Ennico www.creators.com "My brother and I have a limited liability company (LLC) for our garage business. My brother really is the 'workhorse' in this business - I put in the startup money, and I sometimes do the books - and it's a pain in the neck for him to have to figure out his estimated taxes four times a year. Isn't there a way we can put him on a payroll, pay him a regular salary, and withhold taxes just like we would for an employee who didn't own a piece of the business? You won't believe this, but I've spoken to three different accountants and I've gotten three different answers. Help!" I'm not surprised at all. This is one of the toughest tax questions involving LLCs, and I have devoted at least three prior columns to this subject. Let's begin with the basics. Your LLC is treated as a partnership for tax purposes unless you choose to be taxed another way. If an employee is not a partner (owner) of the business, you can put her on a payroll, withhold income, Social Security (FICA) and Medicare taxes, and deduct her salary the same as if you were a corporation. If the employee is also an owner of the LLC (called a "member"), however, the rules start to get complicated. Legally, a member of an LLC cannot receive a "salary" as such from the LLC. There are only two ways a member can get cash out of the LLC: she can either take a "draw", or take a "distribution" of the LLC's profits. A "distribution" to an LLC member is like the dividend a corporation pays to a shareholder - it is a partial return of the monies the member has invested in the LLC, and is based on the member's percentage of the LLC's net income or profit. So, for example, if you and I are 50/50 members of an LLC, and I take out 50% of whatever's left over in the LLC checking account at the end of a particular month (with your approval, of course, so there's enough money in the account to pay future expenses), that is considered a "distribution". A "distribution" does not reduce the LLC's income for tax purposes (it is precisely the LLC's income that is being distributed), and the member taking the distribution must pay all income and self-employment tax on the distribution. A "draw" is an amount paid to a member for services rendered to the LLC, or to reimburse the member for LLC expenses the member has paid out of her own pocket (for example, many members use their personal credit cards to pay LLC expenses in order to obtain "frequent flier" miles the LLC wouldn't qualify for). A "draw" reduces the LLC's income for tax purposes, and the member taking the draw must pay all income and self-employment tax on the "draws". If a member "draws" more than $1,000 during a calendar year, she must estimate the taxes due on the "draws" and pay the estimated taxes four times a year. If a member is allowed to "draw" specific amounts on a regular schedule (like a salary), the "draws" are referred to as "guaranteed payments" for tax purposes. According to Fairfield, Connecticut CPA Russell Abrahms ( rlabrahms@aol.com ), an LLC can deduct guaranteed payments, which are treated as ordinary income to the member who receives them. While admitting that it is a "pain in the neck" for members to have to estimate and pay taxes on their guaranteed payments quarterly, Abrahms says "the brother may actually end up paying less taxes that way than if he were to take a payroll deduction". He explains that "in some states - such as Connecticut - employers who withhold taxes from their employees' wages have to make payments into the state unemployment compensation or disability fund, which members taking a 'guaranteed payment' type draw don't have to do." Abrahms also points out that in this case, the nonworking LLC member may have to pay self-employment taxes (FICA and Medicare) on the draws he takes out of the LLC account. Because he "sometimes does the books", he's not just a passive investor in the LLC. "This is a very hot issue in the tax community right now," says Abrahms, "and we need to delve into the business details before we can determine whether a member's 'draws' or distributions will be subject to self-employment tax." So does anything bad happen if you put an LLC owner on the payroll and withhold taxes from her "guaranteed payments"? See next week's column . . . Cliff Ennico ( cennico@legalcareer.com ) is a syndicated columnist, author and host of the PBS television series 'Money Hunt'. His latest book is 'Small Business Survival Guide' (Adams Media, $12.95). This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com . COPYRIGHT 2006 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. Permission granted for use on DrLaura.com.