Can I draw a salary of 25 percent of my income and pay out the remaining 75 percent to myself in dividends?
Keep in mind that as a single member LLC your business can be classified as either a disregarded entity or corporation for tax purposes. As a disregarded entity you are treated as a sole proprietorship in which you report income and expenses on Schedule C of your 1040 personal tax return. Therefore, the earnings (whether you want to call it wages or dividends) you receive are taxed as personal income and self-employment tax rates. The 25 percent salary and 75 percent dividends scenario you provided would not be applicable here.
If the single member LLC is treated as a C Corporation then, yes, reasonable salary limits would apply. But, in this case the IRS puts a limit on paying too much salary since it is a tax deduction before the corporate income tax is imposed. Dividends--on the other hand--are paid after corporate profits.
I believe the business owner that you spoke with must have a different type of LLC or some other entity since the 25 percent salary and 75 percent dividend payout scenario wouldn't make sense. If his business is considered an S Corporation then the scenario he described would make more sense.
In an S Corporation, if the corporate officers are being compensated with an unreasonably low salary to avoid paying employment taxes (such as FICA) and instead paying out large distributions, that is an immediate red flag and could prompt an audit. A lot of S corps get flagged for audits if the corporate officers have little to no wages. Another Entrepreneur visitor asked about this topic which you should read if you haven't already: As the owner of an S corp, what's the best way for me to pay myself?
Please let me know if you need further clarity after you get more of the facts from the other business owner.
Ryan Himmel, CPA and registered securities analyst, is the founder and CEO of BIDaWIZ.com, a professional network for small businesses and entrepreneurs to obtain trusted advice and services from a team of CPAs, Enrolled Agents, Financial Planners & Tax Attorneys. His team provides answers to the many finance and tax questions that small businesses encounter every day. Ryan has been quoted in The Wall Street Journal, Forbes, Fox Business and Crain's New York, among other publications. Ryan also regularly contributes to the community with his finance and tax blog.