The Mark Perlberg CPA Podcast
The Mark Perlberg CPA Podcast
EP 108 - What Happens When You Take Money Out of Your LLC
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Entrepreneurs often hesitate to withdraw money from their LLCs due to tax concerns, but in most cases, there are no additional tax implications when taking out profits. The tax treatment of withdrawals depends entirely on how your LLC is classified for tax purposes - as a disregarded entity, partnership, S-corporation, or C-corporation.
• Single-member LLCs (disregarded entities): Taking money out is simply an owner's draw with no tax implications
• Profits are already taxed on your personal return whether you withdraw them or not
• For partnerships: Distributions to partners typically have no additional tax consequences
• Guaranteed partnership payments are taxed as ordinary income and subject to self-employment tax
• S-corporation owners must pay themselves a reasonable salary subject to payroll taxes
• Distributions from S-corps can provide tax advantages but require proper planning
• C-corporations face "double taxation" when paying dividends to owners
• Always transfer money to personal accounts rather than paying personal expenses from LLC accounts
• Maintain proper separation between business and personal finances to protect your liability shield
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I want to bring clarity to this common question once and for all here that I get asked by lots of entrepreneurs, and the question is what happens when I take money out of my LLC? I see so many entrepreneurs especially early stage entrepreneurs with cash sitting in their company afraid to take the cash out because they're afraid of all the tax liabilities that are going to happen here. So here we're going to get straight to the facts and I'm going to hope that this video gives you absolute clarity on what happens when you take money out of your LLC and what potential tax implications are there at all. But before we even do that, we have to understand what type of entity this LLC is. Is it a single member LLC, which is a disregarded entity, or sole proprietorship? If you don't know what your LLC is and is one owner, that's probably what it is we may have a multi-member partnership LLC. We can have an S-corporation. An LLC, believe it or not, can elect to be taxed as an S-corporation, and an LLC can also elect to be taxed as a C-corporation. This is extremely important for you to know to understand the tax implications here.
Speaker 1:Now, the majority of you listening do not have C-Corps If you don't know what it is. Again, it's probably just going to be a sole proprietorship or disregarded entity and that's going to be the easiest to plan for here. And if you have a C-Corp or S-Corp entity election for your LLC, you should know about that. Hopefully you know about that at the very least, because you would have to deliberately file to be taxed of that. It's not going to be as though you applied to be an LLC and, unbeknownst to you, someone, some random office, chose for this to be a C-Corp or S-Corp. So let's talk about sole proprietorships and for a lot of you listening, this will give you all the information you need. A lot of our real estate investor clients. If you're a single member LLC, we would recommend that be a sole proprietorship, schedule E reported on your 1040. This is going to apply to you as well. So if you are a single member LLC, when you take the money out we would just call this an owner's draw. It's not like you're paying yourself a salary of any kind and there's no tax implications at all.
Speaker 1:Think about the logic of this. Let's say I have an LLC, I sell a bunch. I sell a bunch. Let's say I make $100 profit in my lemonade stand. The profit is calculated as a revenue. How much people bought the lemonade for, minus the cost, the cost of the lemons and the sugar and materials to sell the lemonade? So I have $100 profit. I'm going to pay taxes on the $100 profit. Well, I have $100 of cash resulting from my profit sitting in my pocket. Or let's say, to better illustrate what happens here, let's say that $100 digitally is in the LLC. When I take the funds out of that LLC and put it in my bank account, I'm just taking my profits and transferring it from the LLC into my personal account. It is not a business transaction. If we had a set of books, this would be a change in our assets or our cash, as a balance sheet transaction is not an income statement transaction. There is no taxable event in this instance at all. Okay, we are just taking our profits, which we've already paid taxes on, and now we are distributing them to ourselves so we can actually use the money that we've earned in our day-to-day lives. Very simple.
Speaker 1:Now let's move on to partnerships. What you're likely to find here is that when you take the money out of a partnership, it's going to have the same treatment Most of the time when the money gets taken out of the partnership, it is a partnership distribution, meaning when we do that tax return, we have a partnership return and we show the profits of the partnership's activities and we take some of the profits or just some of the cash in the entity and we want to give it to the partners, because the purpose of running a business is not just to keep the money in the entity and we want to give it to the partners, because the purpose of running a business is not just to keep the money in the business itself. We want to have profit to support ourselves. Right, this is a business, so we do a distribution, so you can live on your profits within the partnership. Where we see a challenge is if we do guaranteed partnership payments. So let's say we have a couple of partners and one member is guaranteed to be paid for a certain service, x number of dollars. Well, when that happens, it's a deduction to the partnership and then it is taxed as ordinary income to the partner receiving that amount of income. I'm not a big fan. I try to avoid guaranteed partnership payments when we structure a partnership. Sometimes it's necessary and that's fine. The tricky thing here is when we have guaranteed partnership payments. We pay social security and Medicare taxes. We also don't get that beautiful qualified business income deduction, so we lose that 20% QBI deduction on those transactions.
Speaker 1:Now you may find that the that, or at least a conversation may arise on well, what if we take a distribution in excess of our basis? So there could be an occasional instance where there's a risk that you take out cash in excess of basis. And to simplify, what basis is here in a partnership, a basis is essentially your share of the stuff in the entity. So if you take out more than your share of stuff I'm sorry if you're an accountant listening to this, I know that you're going to be saying, oh, there's a much, but that's not exactly what it is. We're going to keep this simple for the entrepreneurs here. So your share of what you've put into this thing, this partnership. If you get a cash distribution that exceeds your share of basis or your stuff, which is essentially the money you put in, the money that you borrowed to build the partnership, and then the profits that exist in this company, if you take out an amount in excess of that, that could be considered a distribution in excess of basis and is taxed as capital gains at anywhere from zero to 20%. Now, the probability of this happening is very low because that gives us basis.
Speaker 1:So a lot of you real estate investors, before you start freaking out over this whole basis conversation with distributions, let's talk about how this plays out. So you invest into a real estate syndication, you put $100,000 into it and then let's say we have some capital, we have some cash out refis and we have a profit distribution. Well, because you have debt, even though we only have a $100,000 initial capital contribution into this company, when we buy the real estate we're likely using leverage. So let's say you own one-tenth of a $2 million property. So let's say this partnership put $100,000 down to buy a $2 million property. The basis in that property is $2 million, even though you're not using all your cash. You're borrowing money in a mortgage situation to acquire more assets and your share of that debt that the partnership takes on is going to give you additional basis. So if you are borrowing in that instance, if you have 50% or let's say whatever percentage of the debt here in this example, 10% your basis wouldn't be $100,000. It would actually be the $100,000 you put in plus your share of the debt used to acquire that property. So let's say you have a 10% ownership in the partnership and it borrowed a million dollars, so your basis is actually going to be $200,000. So even if you get a cash out refi that gives you your $100,000 back, you're still not going to get a distribution in excess of basis because that debt gives you all this other basis. So the probability of you taking a distribution in excess of basis in a partnership is still very low. So for those of you investing passively in real estate or in other partnerships with debt, you don't have to really worry about this concept at all with partnerships.
Speaker 1:Very rare that this comes into play Now with S-corporation owners. So if you have an LLC taxed as an S-corp, it's a little different because when you have debt, when you borrow money, that doesn't give you a basis. So we've had instances where clients bought heavy equipment or trucks and they used leverage to buy that truck and it created a tax loss on their return. Well, that S-corp, while it did have a loss, they didn't have enough debt because they're using borrowed money to purchase the assets. It didn't give them enough credit. Essentially, the way that we looked at this again, you don't have enough stuff that you put in, because the borrowed money is not yours, it's borrowed and you don't get all the available write-offs.
Speaker 1:So with S-corporations there's a few ways we take our money out. We do a distribution. This is just an owner's distribution so we can pay ourselves. It's very similar to partnerships here, where you have your profit, you take out your share of the profit and it's already being taxed and recorded on the S-corp return. You're just taking your share of the profits, no tax implications. We also pay ourselves a salary and that salary should be paid in an amount that is equivalent to the fair market value of the services you perform in your S-corporation. That amount is going to show up as though you are an employee of your S-corporation, so you're going to get a pay stub with withholdings and taxes taken out of that.
Speaker 1:Now, if and when you're taking money out of that S corporation, if you have debt in the S corp, you may want to talk to your advisor and make sure you're navigating this concept of the possibilities of distributions exceeding your basis in the S-corporation. Now, if you don't have debt, most likely this is not going to be an issue, and I know the purists and the hardcore accountants here are going to say oh well, let's talk about the law and exactly how it applies. Let's keep things simple for the entrepreneurs If you're an S-corp owner, you're taking money out. There's likely no tax implications at all. The entrepreneurs If you're an S-corp owner, you're taking money out there's likely no tax implications at all. But make sure you're working with your advisor and someone who actually knows what basis is and the unique treatment of debt basis in S-corps. There are all sorts of strategies to make sure that this isn't an issue for you.
Speaker 1:Now another thing to think about with these S-Corps and partnerships, what are you paying taxes on? You are paying taxes on the profit of the entity itself. So what is the net income of the partnership? What is the net income of the S-Corporation? That's the profits. That's essentially what you're paying taxes on. If, if you have a partnership distribution, if you have guaranteed partnership payments, that may be taxable to you, or there are some rare instances where you have distributions in excess of basis for partnerships or S-Corps. While unlikely, you still want to know about it. And then, as an S-Corp owner, you are most likely going to have to pay yourself a salary and that's taxed, just like you would be paying taxes out of any other job that you have, with pay stubs and the withholdings taken out. You pay your payroll taxes, so your Medicare and your Social Security, and it's a tax deduction from the entity itself because they're paying the officer.
Speaker 1:And finally, let's get into C corporations. C corporations are tricky to take the money out because the C corporation pays its own taxes at 21% flat rate. But now we have all these other challenges of double taxation and a lot of you listening who are afraid to take money out of your LLC is most likely because you see, these C-corps and this whole concept of double taxation is scaring the heck out of you. Like I said earlier, it's unlikely. We have to worry about distributions in excess of basis. There's likely no tax implications at all when you just take the money out of your account. It's just transfer.
Speaker 1:But with C-Corps we need to be a little bit more methodical in our understanding and our initiatives to take money out of the C-Corporation. So what we would expect to see here is you pay your profits in the C Corp at 21% and when we take money out of the C Corporation it cannot be a distribution, it is going to be a dividend and that's going to be taxed as a taxable dividend. So, and how much is that going to be taxed? That's going to be taxed. That's going to be taxed at anywhere from 0% to 20%. Most of you guys are going to be at 15% or, if you're higher in income earner, 20% is taxed, just like capital gains. And when we think about the challenges here is you've already paid taxes on that income at the 21% at the entity level and then you're going to pay taxes on it again when you take your share of profits from the C-Corp into your personal account. Some other things to consider here is you can still pay yourself a salary out of the C-Corp. Salary is deducted from the C-Corp as a business expense to pay its officer or member and you are paying taxes on that just like you would any other salary, at your marginal rate plus payroll taxes.
Speaker 1:Some other opportunities and there are some more advanced ones to consider there we're not going to have time to dive into, but some people may have an opportunity to borrow money from the C corporation. So if you're borrowing money, then it's not considered a taxable dividend and you want to be careful here. This could be a slippery slope and you want to make sure that you're being compliant in the manner by which you borrow money from your C corporation. That is to be a legitimate loan with interest, properly documented. And there are a lot of instances, for compliance reasons, where you're not allowed to borrow from your C-Corp or you're limited on what you can borrow from your C-Corp to maintain compliance.
Speaker 1:Some other things to consider with the C-Corporation is timing of the dividends. Let's say we know we're going to drive into a lower bracket in a later year. We time the dividend so when we receive it we're in that $0 cap gains or dividend bracket. When we keep the money out of the years where we may find ourselves in the 20% dividend bracket, there are also ways where we can say, hey, we're going to get this taxable dividend. We're going to deploy that money onto something in our 1040 that will reduce our overall personal tax as well.
Speaker 1:Now, because of all these challenges and nuances on C-Corp taxation, it's rare that you are going to be recommended a C-Corp, but there are some really wonderful tax advantages for C-Corps as well, in particular when it comes to the exits of the C-Corps and certain fringe benefits we can give ourselves, because a lot of the time when we have sole props or S-Corps and partnerships, we can't give ourselves the same type of benefits and have the same tax advantages, because it's kind of like we're giving benefits to ourselves so it's kind of disregarded. But when we have a C-Corp we can give ourselves more benefits. So there are some really unique instances and opportunities with C-Corps. But if you don't have a qualified, skilled and advanced tax strategist who understands how to navigate this landscape, don't DIY this. Don't do this on yourself.
Speaker 1:We see so many people misadvised on creating these C-Corp management companies and C-Corps that they don't even know what to do with them and how to take the money out. Most likely you haven't been advised on creating the C-Corp, but if you're a high income earner and you're doing advanced tax planning, there may be some opportunities there. But for the majority of you that's likely not an issue and for the majority of you, especially if you're a sole proprietorship, you can probably just take your profits, transfer them from the business account to your personal account. You now have your cash to do whatever you want with it and you're good to go.
Speaker 1:Another thing I want to add for the purpose of maintaining the legitimacy of your LLC is while we can transfer the money from our LLC to our personal accounts.
Speaker 1:We do not want to pay for personal items out of our LLCs because that would be piercing the corporate veil and if you were scrutinized or maybe being sued, they could evaluate this LLC and say it's actually covering this guy's LLC and say it's actually covering this guy's Netflix account and it's actually an illegitimate business entity.
Speaker 1:All right, I hope this helps and if you still have questions, some of the things we can do to help you out are we can do a free strategy session and do a consultation. We'd like to help out as many people as we can, so go to prosperalcpacom slash apply to learn more about how we can help you out. And if you want to get started, to at least start thinking about how you can minimize your taxes and what you can do and what you should know about what's available for you for tax reduction, go to taxplanningchecklistcom for our free mini course. All right, really hope this helps. Put any questions you have in the comments so we can help you gain clarity on this topic of what happens when you take money out of your LLC. Have a great day.