How Is an Owner's Draw Taxed in an LLC?

Paying yourself as an LLC owner seems simple, but the tax implications can be surprisingly complex. The key is not just that you run an LLC, but how you’ve chosen for that LLC to be taxed by the IRS. This guide breaks down how an owner's draw is taxed based on your LLC's tax classification, from a disregarded entity to an S-Corporation.

The First Question: How Is Your LLC Taxed?

Before discussing taxes on draws, we need to clarify a point of confusion. An LLC (Limited Liability Company) is a legal structure created by state law, not a tax classification by the IRS. By default, the IRS treats an LLC in one of two ways:

• A Single-Member LLC is automatically treated as a "disregarded entity," meaning, for tax purposes, it's handled like a sole proprietorship. All income and expenses are reported on the owner’s personal income tax return.
• A Multi-Member LLC is treated as a partnership, with income and expenses passed through to the partners to report on their personal returns.

However, an LLC can elect to be taxed differently. Both single-member and multi-member LLCs can choose to be taxed as an S-Corporation or a C-Corporation by filing the appropriate forms with the IRS. How you pay yourself—and how those payments are taxed—changes dramatically with each of these classifications.

Taking a Draw When Your LLC is Taxed as a Sole Proprietorship

If you're a single-member LLC and haven't made any tax elections, you're a "disregarded entity." In this case, there's no legal distinction between you and your business for tax purposes. Taking money out of the business is a straightforward process known as an owner's draw.

How a Draw is Taxed

An owner's draw is not taxed directly. Instead, you are taxed on the entire net profit of your business, regardless of how much you actually "draw" out for personal use.

This is a core principle of pass-through taxation. The LLC's profit "passes through" to you directly and is reported on Schedule C of your Form 1040. Because there are no withholdings on an owner's draw, you are responsible for paying two types of tax on that profit:

1. Self-Employment Tax: This is the self-employed version of Social Security and Medicare taxes (FICA). It's calculated on 92.35% of your net business profit. For 2024, the rate is 15.3% (12.4% for Social Security up to the annual limit and 2.9% for Medicare with no limit).
2. Federal and State Income Tax: The net profit is added to any other household income to determine your income tax liability.

You cover these tax obligations by making quarterly estimated tax payments to the IRS and your state revenue department using Form 1040-ES.

Example: Sarah's marketing consultancy LLC operates as a disregarded entity. In one year, her business earns $100,000 in net profit. She takes a total of $60,000 in owner's draws to cover her living expenses. Sarah is taxed on the full $100,000 profit—not the $60,000 she took home. She will owe self-employment tax and income tax on that $100,000.

Distributions in an LLC Taxed as a Partnership

If your LLC has two or more members and you haven’t made a special tax election, you're taxed as a partnership. Much like a sole proprietorship, the partnership itself doesn't pay income tax. Instead, the profits pass through to the partners.

Payments to partners can come in two forms: guaranteed payments and distributions (draws).

• Guaranteed Payments: These are payments made to a partner for services rendered or for the use of capital, determined without regard to the partnership's income. Think of it like a salary paid to a partner. These payments are subject to self-employment tax for the receiving partner.
• Distributions (or Draws): These are distributions of the partnership's profits to the partners, typically based on their ownership percentage outlined in the partnership agreement.

How Distributions are Taxed

Similar to a sole proprietorship, partners are not taxed on their draws directly. Instead, each partner is taxed on their distributive share of the partnership's profits. This is their portion of the company's total profit for the year, whether they received it in cash or not.

The partnership files an informational return (Form 1065), and each partner receives a Schedule K-1 detailing their share of the income, deductions, and credits. The partner then uses this K-1 to report the income on their personal tax return and pay self-employment tax and income tax on their entire share of the profits.

Example: Ben and Jerry each own 50% of an LLC taxed as a partnership. The business has a net profit of $150,000. Ben takes a $50,000 draw, and Jerry takes a $75,000 draw. Regardless of their draws, each partner will receive a K-1 showing $75,000 in profit. They will each report and pay self-employment and income tax on that $75,000.

Salary and Distributions in an S-Corp LLC

This is where everything changes. If you elect for your LLC to be taxed as an S-Corporation, you become both an owner (shareholder) and an employee of your own company. You can no longer pay yourself solely through owner's draws.

Instead, as an owner who provides services to the business, you must pay yourself a "reasonable salary."

1. The Reasonable Salary

Your reasonable salary is paid through a formal payroll system, just like any other employee. You will receive a W-2 at the end of the year. This salary is subject to FICA taxes (Social Security and Medicare), which totals 15.3%. As an employee, you pay 7.65%, and the S-Corporation (your company) pays the other 7.65% as a business expense.

The IRS requires this salary be "reasonable" for the services you provide. Factors determining reasonableness include your experience, your duties, and what a similar business would pay someone for an equivalent role.

2. Shareholder Distributions

Any profits remaining in the business after all expenses, including your salary, can be paid out to you as a shareholder distribution. This is the part that is most similar to a draw. The huge difference is the tax treatment: S-Corp distributions are not subject to FICA or self-employment taxes. They are only subject to federal and state income tax.

This potential for tax savings is a primary reason business owners elect S-Corp status. By splitting compensation between a W-2 salary and distributions, you can legally avoid paying the 15.3% Social Security and Medicare tax on the distribution portion.

Example: Maria’s architecture LLC is taxed as an S-Corp. The company has a net profit of $200,000 before her compensation. She determines a reasonable salary for a managing architect is $90,000.

• She pays herself a $90,000 salary via W-2. FICA taxes are paid on this amount.
• The remaining $110,000 can be taken as a distribution.
• She saves the 15.3% FICA tax on the $110,000 distribution, which is a tax savings of $16,830. She still pays ordinary income tax on the full $200,000.

The IRS actively looks for S-Corp owners who pay themselves a very low salary and take large distributions to avoid payroll taxes. Setting a defensible reasonable salary is essential.

Payments from a C-Corp LLC

While less common, an LLC can also elect to be taxed as a C-Corporation. In this structure, the concept of an "owner's draw" does not exist at all.

A C-Corp is a completely separate taxpayer from its owners. The corporation pays corporate income tax on its profits (Form 1120). Owner-employees must be paid a reasonable W-2 salary for services they provide, which is a deductible business expense for the corporation. Any profits remaining after taxes and expenses can be distributed to shareholders as dividends. These dividends are then taxed again at the shareholder's personal tax rate, a phenomenon known as double taxation.

How to Record Owner's Draws in Your Accounting Software

Regardless of how your draw is taxed, you need to record it correctly in your books to keep your financial statements accurate. An owner's draw is never a business expense and should not appear on your Profit & Loss statement.

In accounting software like QuickBooks or Xero, a draw is a reduction of owner's equity. You'll typically set up special equity accounts to track these payments.

1. Set Up an Equity Account: Create a new account in your Chart of Accounts. Make the account type "Equity" and name it "Owner's Draw" or "Shareholder Distributions."
2. Record the Transaction:
   • When you transfer money from the business bank to your personal bank, create a journal entry or write a "check" in your software.
   • Debit the "Owner's Draw" account (increasing its balance).
   • Credit your "Cash" or "Business Checking" account (decreasing its balance).

This entry correctly shows that cash left the business and that ownership equity was reduced, all without affecting your report of business profitability.

Final Thoughts

The taxation of an LLC owner's payment is not about the "draw" itself, but about the LLC's chosen tax structure. For disregarded entities and partnerships, you're taxed on your share of the profits, not the amount you take out. For an S-Corp, compensation is split between a W-2 salary and tax-advantaged distributions, requiring careful attention to "reasonable compensation" rules.

Issues like reasonable salary, partnership agreements, and multi-state tax implications can lead to very specific and difficult research questions. Sifting through IRS publications or state tax codes to find a clear answer takes time that could be better spent on client strategy. We built Feather AI to instantly provide accurate, citation-backed answers from authoritative tax sources, helping you provide better advice and operate with more confidence.