LLC Distributions to Members: Everything You Need to Know
LLC distributions to members refer to shares of profits that a limited liability company (LLC) distributes to its owners.3 min read
Updated October 28, 2020:
LLC distributions to members refer to shares of profits that a limited liability company (LLC) distributes to its owners. The way profits are distributed is specified in the LLC's operating agreement. The members of an LLC are required to pay taxes on the distributions they receive.
What Are LLC Member Distributions?
An LLC's members do not own shares of stock in their company. Instead, they receive ownership interests that entitle them to a percentage of the LLC's profits, which is usually proportionate to the amount of capital they contributed to the business.
The LLC's initial owners draft an operating agreement that specifies when and how to profit distributions will be made to members. States do not impose limitations on what the owners include in the operating agreement as long as it is not against state law. There is thus no guarantee that members will receive distributions every year. Nonetheless, although members do not have the right to require profit distributions as they are subject to the terms and conditions of the operating agreement, they will have a legal claim on their shares of profits that the company fails to distribute.
An LLC is allowed to distribute losses differently among its members. For instance, a member who has a 1 percent interest may take 90 percent of the tax losses incurred in a year. In addition, an LLC may distribute money to its investors even if it has no profits or distributes less than its total profits. Such distributions may be characterized as guaranteed payments or interest on a loan. If an LLC has different classes of members and different ways to allocate profits and distributions, it will most likely need the assistance of an accountant or attorney.
LLC Tax Election
It is important to know that the IRS does not regard an LLC as a type of business structure. It requires the members of an LLC to elect to be taxed as one of the recognized business entities. If you are the owner of a single-owner LLC, you can elect to be taxed as a sole proprietorship or corporation. An LLC with multiple members may be taxed as a partnership or corporation.
At the federal level, the tax implications of an LLC's distributions and a corporation's dividends are different. Common and preferred shareholders of a corporation are required to pay income tax on their dividends in the year the payment is made. Nonetheless, since a corporation is taxed separately from its owner, its shareholders are not required to pay income tax on the earnings it retains.
Taxation of Distributions
An LLC that does not choose to be taxed as a corporation is not a separate taxpayer. Instead, each of its members is required to report his or her proportionate share of the company's profits on his or her personal tax returns. As such, the members pay income tax regardless of whether or not the LLC distributes its profits. Nevertheless, if a member pays tax on profits in the first tax year but does not receive any distribution until the following year, he or she does not have to pay additional tax at the time of the distribution.
A multi-member LLC that elects partnership or S corporation tax status is similar to a single-member LLC in that it is not subject to taxes on net income. Rather than paying taxes, the entity passes them through to its members, who will report them on their IRS K-1 forms. The amount reported on a K-1 form may be equal to or different from the distribution received.
When a partner's interest is liquidated, it may represent his or her interest at the fair market value of the company's assets, unrealized receivables, and guaranteed payments. Whether or not it is actually terminated, a partnership is typically regarded as terminating for tax purposes if it stops operating as a partnership or there is a sale or exchange of 50 percent or more of the total interest in capital and profits within 12 consecutive months. Even if the change is more than 50 percent, the 50 percent test excludes the following:
- Property contributions in exchange for a partnership interest.
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