6 Rules for Paying Yourself From an LLC Taxed as a Partnership

6 Rules for Paying Yourself From an LLC Taxed as a Partnership

Half the multi-member LLCs in the country are running an S-corp playbook on a partnership return.

The tell is always the same. Somebody set up payroll for the owners, ran W-2 wages all year, and filed a 1065. It looks tidy. It is wrong, and the cleanup usually spans two tax years.

Paying yourself from an LLC partnership works on a completely different set of rules than paying yourself from an S corporation. Here are the six that matter, starting with the one that causes the most damage.

1. Paying Yourself From an LLC Does Not Mean Payroll

A partner in a partnership is generally not an employee of that partnership. Rev. Rul. 69-184 is the long-standing position, and an LLC taxed as a partnership is a partnership for this purpose.

So there is no W-2 for you. No federal income tax withholding on your own draw. No employer share of FICA on your compensation.

Doing it anyway creates problems in both directions. The partnership has withheld and remitted payroll tax on amounts that were not wages, the partner has a W-2 reporting income that should have been reported on a K-1, and the partner's self-employment tax on the distributive share was never computed. Unwinding it typically means amended payroll returns, amended personal returns, or both.

The single exception people cite is a partner who is an employee of a different entity in the structure, which is a real planning technique and also a structure to build deliberately with counsel rather than discover by accident.

2. Guaranteed Payments Are the Compensation Mechanism

Section 707(c) is how a partnership pays a partner for services or for the use of capital in an amount determined without regard to partnership income.

Practically, a guaranteed payment is your salary equivalent. Three features define it:

It is paid whether or not the partnership is profitable, which is the "guaranteed" part.

It is generally deductible by the partnership, which means it reduces the income allocated to all partners including you.

It is ordinary income to you, reported on your K-1 rather than a W-2, and it is generally subject to self-employment tax.

The operating agreement has to actually provide for it. A partner who takes a fixed monthly amount that the agreement never mentions has created an ambiguity about whether it was compensation or a draw, and the two are taxed differently.

3. A Distribution Is Not Income and Not Compensation

This is the conceptual break that catches almost everyone.

You are taxed on your distributive share of partnership income, which is your allocated share of profit reported on your K-1, whether or not a single dollar was distributed to you. A partnership that earns $400,000 and distributes nothing still produces taxable income for its partners.

A distribution is a movement of cash. It generally is not itself a taxable event. It reduces your capital account and your basis.

The two get conflated constantly, and the consequence is a partner who took $150,000 in draws, sees $150,000 on a line somewhere, and assumes that is what they are taxed on. Then the K-1 shows a $260,000 distributive share and there is no cash left to pay the tax on it.

	Guaranteed payment	Distribution	Distributive share
What it is	Payment for services or capital, set without regard to income	Cash or property moving out to a partner	Your allocated share of partnership income
Deductible to the partnership	Generally yes	No	No, it is the income itself
Taxable to you	Yes, ordinary income	Generally not, unless it exceeds basis	Yes, whether or not cash moved
Self-employment tax	Generally yes for service payments	No	Depends on your role and the entity
Where it shows up	Schedule K-1	Schedule K-1 and your capital account	Schedule K-1

If you can explain that table to your co-owners, you are ahead of most partnerships.

4. The Limited Partner Self-Employment Exception Is Narrower Than You Think

Section 1402(a)(13) excludes a limited partner's distributive share from net earnings from self-employment. That exclusion has been read for years as a structural answer: label the interest limited, and the distributive share escapes self-employment tax.

The Tax Court has been narrowing that reading. In Soroban Capital Partners, the court held that state-law limited partner status is not determinative and that a functional analysis applies, looking at what the partner actually does. Partners who were limited in name only, while working actively in the business, did not qualify for the exclusion. The court reached that result in a memorandum opinion, T.C. Memo 2025-52, and the matter has continued on appeal.

Three honest caveats. This is developing law, not a settled rule. A memorandum opinion and an appeal in progress is a weaker foundation than a statute. And the analysis turns on facts specific to investment management partnerships, so its reach to an operating business is not fully mapped.

What is settled enough to act on: a plan whose entire self-employment tax saving depends on a label rather than on what you do is a plan with real exposure. If someone sold you that structure, the question to ask now is what happens to your tax position if the label does not hold.

5. Basis and Capital Accounts Decide What You Can Actually Take

Two limits that only surface at the worst moment.

Distributions above basis create gain. Under section 731, a cash distribution exceeding your adjusted basis in the partnership interest generally produces capital gain. A partner who draws heavily out of a business funded by debt can hit this and owe tax on cash they thought was a return of their own money.

Losses stall at basis. Under section 704(d), your deductible share of partnership loss is limited to your basis, with the excess suspended until basis is restored. Partners who counted on a loss to offset other income sometimes find it is not available this year.

Your capital account and your tax basis are also two different numbers, tracked differently, and they diverge. If your accountant cannot produce your current tax basis on request, that is worth resolving before the next distribution rather than after.

6. Benefits Run Through Guaranteed Payments, Not Payroll

Partner health insurance, retirement contributions, and similar items are generally handled as guaranteed payments rather than as employee benefits.

Health insurance premiums paid by the partnership for a partner are typically treated as a guaranteed payment included in the partner's income, with the partner then potentially claiming the self-employed health insurance deduction on their own return. Retirement plan contributions for partners are generally computed on net earnings from self-employment rather than on a W-2 wage figure, which is a different calculation with a different answer.

And because there is no withholding on any of this, quarterly estimated payments are entirely on you. A partnership that does not distribute enough cash for its partners to make estimates is creating a personal cash flow problem for every owner, and that belongs in the distribution policy rather than in each partner's private stress.

Where Paying Yourself From an LLC Partnership Breaks Operationally

None of the above is exotic tax law. It fails because the accounting system was never set up to reflect it.

System Six is based in Seattle and was founded in 2009, working with small business owners and real estate investors on accounting operations. Partnership capital account tracking is exactly the kind of unglamorous, high-consequence work that gets deferred: separate accounts per partner, guaranteed payments coded as guaranteed payments rather than as owner draws, and a distribution policy that someone actually follows.

The limitation is worth naming. Bookkeeping and accounting operations are not the same as partnership tax planning. Whether your interest qualifies under 1402(a)(13), how to allocate under an agreement with tiered waterfalls, and whether to restructure are questions for a tax practitioner working with your operating agreement, and the answer for a real estate partnership is often different from the answer for a services firm.

The Two-Minute Diagnostic

Ask your accountant three questions.

What is my current tax basis in the partnership? What portion of last year's K-1 income was guaranteed payment versus distributive share? And is my distributive share being treated as subject to self-employment tax?

If any of those takes more than a day to answer, that is your finding.

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Frequently Asked Questions

Can an LLC member take a salary? Not a W-2 salary from an LLC taxed as a partnership. Rev. Rul. 69-184 treats a partner as not being an employee of the partnership, so the equivalent of a salary is a guaranteed payment under section 707(c), reported on the K-1 and generally subject to self-employment tax. An LLC that elected S corporation or C corporation treatment is a different situation, and there owner wages on a W-2 are normal.

What is the difference between a guaranteed payment and a distribution? A guaranteed payment is compensation for services or capital, set without regard to whether the partnership is profitable, generally deductible by the partnership and ordinary income to the partner. A distribution is a transfer of cash or property that reduces the partner's capital account and basis and generally is not itself taxable. One is an expense of the business; the other is a movement of the partner's own equity.

Do LLC members pay self-employment tax on all their income? Guaranteed payments for services are generally subject to self-employment tax. Whether the distributive share is depends on the partner's role and the entity, and the limited partner exception under section 1402(a)(13) is being read narrowly by the Tax Court, which has applied a functional analysis to look at what the partner actually does. Because this is developing law, treat any structure built purely on a limited partner label as a position to review.

How do I know if my draws are too high? Compare cumulative draws to your tax basis in the partnership interest, not to the bank balance. Distributions exceeding basis generally produce taxable gain under section 731, and a partnership that distributes more than it earns steadily erodes every partner's basis. A distribution policy that reserves for taxes first and distributes what remains, with a basis check each quarter, prevents most of these surprises.

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About the author: Kimberly Green is the cofounder of Sam's List, where business owners and high earners find vetted CPAs, financial advisors, and fractional CFOs. She's met one-on-one with 400+ financial professionals and writes from the real data behind thousands of client-advisor matches. Ask her anything about finding an accountant - she's heard it all, including the questions people are afraid to ask.