One of the most common (and costly) mistakes I see business owners make is paying themselves the wrong way from their LLC.
And no — it’s not just an internal bookkeeping preference.
The IRS absolutely cares how you do this, and getting it wrong can lead to back taxes, penalties, and lost tax savings.
Let’s break it down in plain English.
Step One: What Kind of Income Does Your LLC Earn?
How you pay yourself depends entirely on what type of income your LLC generates.
There are two very different scenarios:
- Active business income (services, commissions, construction, flips, consulting, retail, etc.)
- Passive income (long-term rental real estate)
Each has different rules — and mixing them up is where people get into trouble.
Active Income + S-Corp Election = Payroll Is Required
If your LLC earns active income and you’ve elected to be taxed as an S-Corporation, the IRS requires you to do one key thing:
👉 Pay yourself a reasonable W-2 salary
This salary:
- Must be run through payroll
- Is subject to payroll taxes (Social Security & Medicare)
- Should reflect what someone would reasonably be paid to do your job
After that salary is paid…
This Is Where the Tax Savings Happen
Any profit above your W-2 salary can be taken as owner distributions.
Why that matters:
- Distributions are not subject to the 15.3% self-employment tax
- You still pay income tax, but you avoid thousands in payroll taxes
When structured correctly, this is one of the simplest and most effective tax strategies for high-income business owners.
When done incorrectly?
It’s one of the fastest ways to trigger IRS scrutiny.
Rental Properties? The Rules Flip Completely
Now here’s where many real estate owners get tripped up.
If your LLC only holds rental properties, the income is generally considered passive.
That means:
- ❌ You should not run payroll
- ❌ You should not pay yourself a W-2
- ❌ An S-Corp election is usually unnecessary (and often harmful)
Instead, the correct approach is simple:
👉 Transfer money out of the LLC as owner distributions whenever you need it
No payroll.
No reasonable salary analysis.
No employment taxes.
Running payroll for rental income is one of the most common (and avoidable) mistakes I see.
Why This Distinction Matters So Much
Getting this wrong can lead to:
- IRS reclassification of income
- Back payroll taxes and penalties
- Lost tax savings you thought you were getting
- Compliance issues that snowball over time
Getting it right means:
- Staying fully compliant
- Protecting your tax strategy
- Keeping more of your hard-earned money
The Bottom Line
There is a right way to pay yourself from an LLC — and it depends on:
- Whether your income is active or passive
- Whether an S-Corp election actually makes sense
- Whether payroll is required or prohibited
This distinction is one of the most overlooked areas in small business tax planning, and it’s exactly where professional guidance pays for itself.
If you’re unsure whether you’re paying yourself correctly, it’s worth reviewing now — not after the IRS does.