Last editedOct 20213 min read
When registering a limited liability company (LLC), one of the first decisions to make is how the members will get paid. Rather than receiving an hourly wage or salary, LLC members have some different options to choose from – one of which is a guaranteed payment plan. So, what is a guaranteed payment in an LLC, and how does it work? We’ll explore these questions below.
What are guaranteed payments in an LLC?
Due to the way the company structure is set up, LLC owners, or members, are classified as different to standard employees. This means they can’t receive the standard salary that comes along with being an employee. Instead, they can either take profit-sharing distributions or guaranteed payments. What is a guaranteed payment in an LLC? This simply refers to guaranteed minimum compensation for a member’s work with the company, whether it’s turning a profit or not.
It’s natural for a business to experience periods of ebb and flow with its net income. With guaranteed payments, LLC members are assured that they’ll still receive compensation during periods when the company isn’t generating profit. These payments are considered the highest priority in the company’s financial outgoings, which makes them “guaranteed” even if it results in a loss for that accounting period.
How do LLC guaranteed payments work?
All details about guaranteed payments must be written down in the company’s operating agreement. An LLC guaranteed payments operating agreement states the following information:
Who will receive guaranteed payments
When the payments will be sent
Guaranteed payment amount
It’s important to state these details in the LLC guaranteed payments operating agreement to keep your company finances in line with tax regulations. The Internal Revenue Service (IRS) doesn’t allow LLC owners to act as employees that draw salaries. Instead, guaranteed payments are treated as a business expense and should be recorded on the profit and loss statement. This ensures they’ll be taxed accordingly.
What are guaranteed payments in an LLC used for? They help keep business owners afloat during times of financial uncertainty, particularly for new companies. It’s not unusual for businesses to take years to start turning a profit, during which time the LLC members might not see any compensation. Guaranteed payments offer a way to ensure regular compensation despite net income.
Alternatives to guaranteed payments LLC
Can an LLC receive guaranteed payments? Yes, but there are two additional options to choose from:
Draw payments
The LLC member can take draw payments at any time. Draw payments are taken either from profits or treated as an advance payment drawn from future profits. This means they don’t need to be considered a business expense, and they are not recorded on the P&L statement. They’re treated as a one-off distribution of profits that have been recorded on the balance sheet. Draw payments are best suited to single-member LLCs and sole proprietorships.
Distribution payments
Another alternative to guaranteed payments is a distributive payment. Distributive payments are similar to draw payments in that they’re taken from profits and not recorded as a business expense. The LLC operating agreement will typically state scheduling and allocation details for these distribution payments. They’re also usually based on a percentage mirroring each member’s stake in the company.
How are LLC guaranteed payments taxed?
Guaranteed payments are treated differently to regular wages by the IRS. For example, LLCs don’t need to pay the Federal Insurance Contributions Act (FICA) contribution or payroll taxes. Instead, guaranteed payments are reported individually by members as self-employed income. This means they’ll pay self-employment taxes on a quarterly basis. For the business, these payments are treated as a business expense for tax purposes.
Can an LLC receive guaranteed payments – the pros and cons
Are guaranteed payments right for you? Here are a few pros and cons to consider.
Advantages:
They reduce taxable income for the business
There’s no need to pay FICA tax
Members are ensured regular income despite profit and loss
Disadvantages:
The LLC must make payments even if it’s operating at a loss
Members will need to pay self-employment taxes on their payments
Members will also need to pay the company’s share of FICA tax
Whether or not LLC guaranteed payments are best for you depends on the size of your LLC, profits and losses, and tax situation. It’s worth consulting with an accountant if you have any questions about this type of business structure and payment plan.
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