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What Is An LLC Distribution
An LLC distribution is a phrase used to refer to the sharing of profits generated by a limited liability company with its members.
A distribution can be in the form of cash or property.
In a limited liability company, the LLC operating agreement outlines how profits are distributed to its members.
A “distribution” is essentially a “payment” made by the LLC to its members coming from business profits.
What’s interesting about LLCs is that they can choose to be taxed as a corporation or a partnership.
If the LLC is taxed like a C Corporation, the distribution may be considered a salary, return of capital, or distribution in partial or complete liquidation of the LLC.
If the LLC is taxed like a partnership, the distribution may be guaranteed payment, return of capital, distribution of operating profits, a disguised sale of property, or current or liquidating distribution.
If the LLC is considered a disregarded entity, the distribution in cash or property will have no tax ramifications as they are already considered the owner’s assets.
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LLC Distributions As Per Operating Agreement
An LLC, a limited liability company, is a type of business entity that is owned by its members who have an “ownership interest” (as opposed to shares of stock as in a corporation).
Each member’s ownership interest will entitle him or her to receive a percentage of the LLC’s business profits.
In most cases, a member’s LLC distribution will correspond to the member’s capital contribution to the LLC.
However, the members of an LLC have the freedom to define how to distribute business profits in their operating agreement.
The law does not specifically regulate how LLCs should distribute profits to their members leaving the members a high level of flexibility in defining distribution mechanics suitable for them.
When there is a distribution to be made, every member will be entitled to receive a distribution as per what’s defined in the operating agreement.
The LLC members are not necessarily guaranteed a distribution but when a distribution is made, they will be entitled to it as per the terms of their operating agreement.
LLC Distribution of Losses
LLCs can distribute business losses to their members.
Although in most cases the business losses will be distributed to the LLC members in proportion to their ownership interest, an LLC has the ability to distribute losses differently if the members choose to do so.
For example, a member that owns ten percent of the LLC interest can be allocated 80% of the LLC losses for a particular year.
The fact an LLC has the ability to determine how much in business losses to pass through to its members will allow business owners to distribute their profits and losses in such a way as to optimize their overall tax exposure.
LLC Profit Distribution
Fundamentally, business owners will form a limited liability company to make money and distribute profits.
When profits are distributed to LLC members, the members’ compensation can be a salary, return of capital, or capital gains from the sale or disposition of assets.
In most cases, LLC distributions are made in accordance with the terms of the operating agreement on how the members realize the return on their investment.
The LLC operating agreement will contain distribution provisions where the members have stipulated how the distributions should be made (for example, it could be prorated based on capital invested, prorated based on ownership interest, or based on other formulas).
LLC Distribution Taxation
By default, an LLC has a pass-through tax status where the LLC profits and losses pass directly to the members.
A single-member LLC is considered a disregarded entity for tax purposes and any distributions in cash or property will have no tax consequence on the member.
The reason that’s the case is that a single member of an LLC, just like a sole proprietorship, owns all the assets of the business already.
A multi-member LLC can elect to be taxed like a partnership or a C Corporation.
By default, the multi-member LLC will have a pass-through tax status where the profits and losses are distributed to the members according to the terms of their operating agreement.
However, the LLC can elect to be taxed like a C Corporation where in that case the business profits will be taxed in the hands of the LLC and the profits distributed to the members will be taxed on each member’s personal income tax.
A key advantage of an LLC is that it can make distributions that are not necessarily proportional to the ownership interest of the members.
This way, the members can choose who gets more or less of the profits and losses so they can optimize their taxes.
LLC Member Tax Liability
Since an LLC is not considered a separate tax entity, by default the members are required to report the company’s profits and losses on their personal income tax.
A member’s tax liability will be established as a function of what the LLC has earned, not as a function of what the member actually received in distribution from the LLC.
In other words, a member may have a tax liability on his or her personal income tax even though no distribution was made by the LLC.
However, if a member has paid his or her share of taxes on the LLC earnings for a given year, if the distribution is made to the member the following year, the member will not be taxed twice.
For multi-member LLCs that elect to be taxed like a partnership (similar to how S Corporations are taxed), the members will report their share of the profits and losses on their K-1 Form.
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LLC Distribution Upon Dissolution
If the members choose to dissolve the LLC, the LLC will make a liquidation distribution to its members.
When the LLC makes a liquidation distribution, it will be required to distribute all property and funds in its possession.
However, the LLC must make sure that the LLC creditors are fully paid.
Then, the LLC must pay any sums owed to its members from prior distributions.
Then, all the excess funds will be distributed to the members that have made contributions to the business.
The excess funds are distributed to the members in the form of profit distribution and such payment will be made as per the terms of the operating agreement.
LLC Distribution FAQs
How does the LLC make a distribution to its members?
An LLC can make a distribution to its members in a variety of ways.
The most common ways of actually paying the members are by check, internal transfer, electronic funds transfer, wire transfer, cash withdrawal, or transfer from an online account.
An LLC distribution can also be a transfer of property.
Are LLCs obligated to distribute money to their members?
The laws in most states do not impose any obligation on LLCs to distribute profits to their members.
It is up to the members to determine when and how distributions are made in their LLC operating agreement.
The members are bound to respect the terms and conditions set out in their operating agreement as it relates to the distribution of profits and losses.
Where are the LLC distribution rules?
The operating agreement of a limited liability company sets out the rules governing the limited liability company’s distributions to its members.
Generally, the LLC will distribute money to its members when the members or managers decide that distribution should be made.
Once all the members of the LLC vote and decide on the distribution, the payments are then made to each member as per the operating agreement terms.
Are distributions always proportionate ownership interest?
LLC distributions are not necessarily always proportionate to the members’ ownership interest.
In fact, an LLC can choose to allocate profits and losses to members based on a different formula.
This means that a member with a 1% interest in the LLC could end up getting 90% of the profits or losses of the LLC.
The allocation of profits and losses is decided by the members.
Do I have to pay taxes if the LLC did not make any distributions?
An LLC is a pass-through entity unless the owners elect to have the company taxed like a C Corporation.
As a pass-through entity, the profits are taxed in the hands of the LLC members.
Even if the LLC does not distribute the profits to the members, the members will have to report the LLC profits on their personal income tax and pay the applicable taxes.
Since LLC members will potentially have to pay taxes even though they did not receive any distribution, the members of many LLCs provide for a mechanic to pay the members enough to cover their tax liability.
How often can an LLC make distributions?
The LLC can decide how often it wants to make a distribution to its members.
The LLC members have the ability to decide on the frequency at which the limited liability company will pay its members.
If the members agree to a yearly distribution, then that’s what the LLC will do.
The members can also choose not to make any distributions.
In that case, an individual member will not have the ability to force the LLC to make a distribution.
What happens if a distribution was done incorrectly?
The LLC members or managers are responsible for the distributions that they make.
If a distribution was done incorrectly in violation of the operating agreement or perhaps state laws, the LLC member or manager may be personally held responsible for the incorrect payment.
If improper payments were made while the LLC members were aware, those who made the distribution or know that it was taking place may be legally held liable.
Are LLC members paid a salary?
Even though some LLC business owners may talk about receiving a salary, the fact is that LLC members are paid a distribution, not a salary.
A salary is a payment that is made to employees.
Typically, the salaries are paid out of the LLC’s gross income, not its net profits.
On the other hand, distributions are paid out of the LLC’s profits (after the salaries have been paid).
By default, single-member LLCs are considered sole proprietorships, and multi-member LLCs as partnerships where the business profits and losses flow through to the business owner.
Takeaways
So there you have it folks!
What is an LLC distribution and how does it work?
Well, an LLC distribution, just like a partnership distribution, is when an LLC takes money out of the business to pay its owners (the members).
Generally, LLC members receive their income in the form of distributions as opposed to a W2 salary or wages.
The IRS does not recognize the LLC as a business entity, as a result, the LLC must choose to be taxed like a recognized form of business such as a sole proprietorship, partnership, or corporation.
Now that you know what is an LLC distribution and how it works, good luck with your research!
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