Can I draw a salary of 25 percent of my income and pay out the remaining 75 percent to myself in dividends?
I'm the owner of a one-person LLC. I was told my another business owner that I didn't have to declared 100 percent of the income (minus expenses) as salary. Is this acceptable to the IRS and if so what are the limits?
Get the working capital your business needs from Entrepreneur Lending, powered by CAN Capital. Learn More »That is a good question and I'm glad to hear that you're consulting with other business owners as that is one of the best ways to improve your business. Please note that the answer to your question depends on factors not provided in your posting but I've detailed some guidance below.
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.