Any member of an LLC can receive a guaranteed payment — as long as the company’s operating agreement allows them to.
Everything You Want To Know About LLC Guaranteed Payments
You have completed the paperwork and started an LLC for business. You also need to figure out how you’re going to pay yourself and other members. You can’t just take money out of the LLC as everything has implications regarding taxes and liability. You have several options and one of those options is guaranteed payments.
For LLC members, guaranteed payments work like a standard salary but there are also quite a few differences. Here is what you need to know about various LLC payment methods and the advantages and limitations of guaranteed payments.
LLC Payment Options For Members
Members of an LLC don’t get an hourly wage or a standard salary but there are other ways to receive payment. There are several such options and each of these options has certain advantages and limitations, as well as tax implications. The three most common payment methods for LLC members are discussed below:
Draw Payments
It is typically the best option for a single-member LLC, partnership, or sole proprietorship. Members may receive payment at any time. It could be a profit withdrawal or an advance payment of future profits. In terms of bookkeeping and tax obligations, it isn’t considered a business expense and does not form part of the profit and loss statement of the LLC. These payments are recorded on the balance sheet as distributions of profits.
Distributive Payments
These work similarly to draw payments as these are not considered a business expense but a distribution of profits. Distributive payments are generally scheduled and allocated as outlined in the operating agreement. Generally, the distribution percentage is proportional to each member’s ownership stake in the LLC.
Guaranteed Payments
These work differently from the draw and distributive payments. The first major difference is that the profitability of the company does not have any effect on the frequency or amount of guaranteed payments. It simply means that an LLC member is scheduled to get a guaranteed minimum amount (hence the name) regardless of the company’s profitability. In terms of record-keeping and tax obligation, guaranteed payments are recorded as a business expense and form part of the profit and loss statement. This is why guaranteed payments are treated by IRS similar to a regular salary.
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Eligibility for Guaranteed Payments
Every LLC member is eligible for guaranteed payments as outlined in the operating agreement. It is important to keep all the payment structures in writing to avoid any potential legal or tax issues.
Getting Paid without Profitability
A business is never guaranteed to turn a profit. It may take months or years and not everyone can wait for that long. This is also true of LLC members who don’t necessarily want to wait that long to get paid. This is the option that allows them to get paid for their investment or work in the company as guaranteed payments are not based on the company’s profitability.
Guaranteed Payment Examples
As the term indicates, a minimum amount of money is guaranteed to the members. It also means that if a member gets money from the LLC in another form such as a distribution, that amount of money is reduced from the guaranteed payment portion. The following example should make things clear:
The operating agreement of an LLC clearly states that a member is eligible for a 20% share of the profits each year and a minimum guaranteed payment amount of $35,000. The LLC made a net income of $150,000 which means the member is eligible for $30,000 of profit. This member will now be paid $5000 as a guaranteed payment and $30,000 as a distributive share.
In case the LLC made more money and the distributive share of the member was more than $35,000, no guaranteed payment would be made to them as the minimum guaranteed threshold has already been met. On the other hand, that member would still receive $35,000 even if the LLC didn’t turn a profit.
Guaranteed Payments – Tax Benefits
LLCs are allowed by IRS to deduct the guaranteed payments from the total revenue of the business. Effectively, it brings down the total taxable amount. Also, guaranteed payments are taxed differently by the IRS as compared to regular wages. It means that LLCs are not required to make FICA contributions on guaranteed payments.
Guaranteed Payments – Advantages and Limitations
Guaranteed payments have certain advantages and limitations just like other payment methods. Here is a quick overview of the major advantages and limitations of this method. Some of the items mentioned below might seem like both an advantage and limitation depending on your perspective – whether you look at it as an individual member or as a business.
Advantages
- Members don’t have to wait for the company to turn a profit to get paid
- It brings down the total taxable income of the business
- This LLC isn’t required to pay FICA tax on these payments
Limitations
- LLC has to make guaranteed payments regardless of its profitability
LLC members are required to pay necessary FICA taxes for them as well as the company’s share
Final Thoughts
Guaranteed payments offer several advantages as well as limitations for LLC members. It is important for you to carefully consider the various pros and cons of different payment methods before choosing one. All payment methods have unique tax implications. You also need to know that there is always the option of picking more than one payment method. Take the help of experienced lawyers or accountants with expertise in this area to carefully evaluate your options and make an informed decision.