May 7, 2010
Can An LLC Member Put Himself On The Payroll? - Part II
Can An LLC Member Put Himself On The Payroll? (Part 2) Cliff Ennico www.creators.com Can a member (owner) of a limited liability company (LLC) who doesn't want to pay estimated taxes be paid a regular salary with payroll deductions just like any other employee? According to Diane Kennedy, a Phoenix, Arizona CPA and author of the best-selling "Tax Loopholes" series of books and audio programs for business owners ( www.taxloopholes.com ), the short answer is "no". "Like a partnership, the owners of an LLC cannot take a salary; they can only take guaranteed 'draws' or distributions," says Kennedy ("guaranteed payments" to LLC owners were discussed in last week's column). But that's not the end of the story, according to Kennedy, whose most recent book is "Tax Loopholes for eBay Sellers" (McGraw-Hill, $24.95). Is the IRS likely to go after an LLC whose members pay themselves salaries and withhold taxes on each paycheck? Probably not. "The IRS is getting its tax money a lot faster if you pay yourself a salary than if you pay estimated taxes four times a year, and they're probably collecting slightly more in taxes than if you withhold regularly, so there's really no incentive for the IRS to spend a lot of time tracking down people who don't follow this rule," Kennedy explains. In other words, "no harm, therefore no foul." Still, Kennedy cautions, no one (including herself, or myself for that matter) is going to tell anyone that it's OK to ignore tax regulations just because the IRS doesn't vigorously enforce them, or doesn't have any real reason to do so. Murphy's Law says that if you ignore a rule because "everybody else does it and gets away with it", you are guaranteed to be the person the IRS chooses to audit as a "test case". Accordingly, Kennedy advises her LLC clients not to pay their members a salary and withhold payroll taxes. Instead, Kennedy says LLCs with working members who don't want to pay quarterly estimated taxes should elect to be taxed as if they were subchapter S corporations. Unlike LLC members, shareholders of a subchapter S corporation who work in the business can take a "salary" and withhold payments from each paycheck, as well as receive a "distribution" of their percentage share of the corporation's profits, usually at the end of the calendar year. Kennedy explains that "the portion of the LLC member's compensation that is treated as a 'distribution' for tax purposes is not subject to self-employment taxes, so you save money, while the portion that is treated as 'salary' is fully deductible to the LLC." Kennedy warns, though, not to be too aggressive in maximizing the amount of compensation that is treated as a "distribution". If you do, you may run afoul of IRS rules requiring employees to receive "reasonable compensation" for their services. Keep in mind also that by electing to be taxed as a subchapter S corporation, your LLC will be subject to all of the legal limitations imposed on subchapter S corporations and their shareholders. So, for example: your LLC cannot have more than 100 members; all LLC members must be 'natural persons' (no corporations or other LLCs allowed); and all LLC members must be U.S. citizens or "green card" holders (no foreign nationals or illegal aliens). An LLC can elect to be taxed as a subchapter S corporation in two steps. First, your LLC should file IRS Form 8832 (and any comparable state tax form) electing to be taxed as if it were a corporation. Then, within 75 days of filing Form 8832, your LLC would file IRS Form 2553 (and any comparable state tax form) electing "subchapter S corporation" tax treatment. Kennedy adds that if you live in a community property state (such as California), the spouses of all LLC members will have to sign IRS Form 2553 even though they will not be playing a role in the LLC business. The bottom line: having your LLC elect to be taxed as a subchapter S corporation will enable the members to draw salaries and withhold taxes just like any other employee, without violating any tax laws, but you will probably need the help of a good CPA or tax advisor before you consider setting up an arrangement like this. 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.

Posted by Staff at 1:48 AM