Key Takeaways

  • LLC ownership can be split using percentages or membership units, with flexibility for profit distribution and voting rights.
  • Ownership does not need to match capital contributions and can be defined in the Operating Agreement.
  • LLCs can allocate profits and losses in ways that differ from ownership percentages if legally documented.
  • Changes to ownership or profit allocations should be clearly documented and updated in official LLC records.
  • Dividing or restructuring an LLC has legal and tax implications depending on how the division is executed.

LLC shares are not shares in the traditional sense. An LLC is a limited liability business structure, which includes features of both a partnership and an organization. In addition to being the least complex business structure, an LLC is also flexible.

Unlike a sole proprietorship or partnership, an owner's interests in an LLC are not represented by shares. In addition, an LLC provides legal protection for its owners' assets and results in limited liability for financial obligations related to the business and debts. Establishing an LLC also results in the benefit of pass-through taxes.

What Is an LLC?

  • The precise requirements and formation for establishing an LLC depend on the state. On the whole, it is a straightforward procedure.
  • Generally, setting up an LLC involves completing a minimal amount of paperwork and submitting the LLC fee.
  • The ownership of an LLC is determined by percentage ownership.
  • An LLC can split its ownership interest in various ways: Owners are called members and members can have varying voting rights and different claims to assets in the business.
  • As a result, an LLC must have an operating contract in place that sets out how the interests will be organized.

LLC Ownership Percentages

The ownership of an LLC is indicated in two ways. The first is by percentage and the second is by membership units. Membership units are the equivalent of shares in a corporate structure. These units give members the entitlement to vote and to a portion of business profits. 

Another difference between an LLC and a corporation is that an LLC can allocate its members' interests however it likes. This does not have to depend on the capital or assets that a member gives to the LLC. For example, John gives $10,000 to an LLC and acts as a silent partner. Meanwhile, Greg does not provide any money but manages the company every day. Both members can still divide the interests on an even basis.  

How to Split Ownership in an LLC

When forming or restructuring an LLC, understanding how to split ownership in an LLC is critical for aligning responsibilities, profits, and decision-making authority. Ownership can be split in several ways, each with legal and financial implications.

Common Ownership Split Methods:

  • Equal Ownership: Each member holds an equal percentage (e.g., 50/50 in a two-member LLC).
  • Proportional Ownership: Members’ ownership percentages match their capital contributions.
  • Disproportionate Ownership: Members can agree to unequal splits regardless of investment, especially if some contribute services or intellectual property.

Ownership splits are formalized in the LLC’s Operating Agreement. This document should:

  • Specify each member’s percentage of ownership.
  • Define voting rights (which may or may not match ownership).
  • Explain how profits and losses are distributed.
  • Outline procedures for adding or removing members.

In multi-member LLCs, clarity is especially important to prevent disputes. Be sure to update ownership percentages in state filings when required.

Members' Interests

LLCs can be structured according to various levels of member interests. These offer versatility for significant distributions of profits and voting rights. For instance, it's possible to establish a class for “special-voting” units. These could allow for 10 votes per unit or a particular amount of earnings before the “regular voting” units. 

Selling owners' interests must be carried out according to government and state securities regulations. However, if you are not promoting the sale of the interests and if you are involving a group of fewer than 35 investors, most of the rules will not apply. 

In contrast, if you are attempting to involve a bigger group of investors to raise a large sum, it might be necessary to seek advice from a lawyer. 

Allocating Profits and Losses Among Members

While many LLCs allocate profits and losses in proportion to ownership, this is not mandatory. The Operating Agreement can establish an alternative method of distribution, allowing for creative arrangements.

Examples of Custom Allocation:

  • A member with a 25% ownership might receive 40% of profits due to their role in daily operations.
  • A silent partner contributing capital but no labor might receive profits last, after working members.

However, these allocations must satisfy IRS “substantial economic effect” rules, ensuring that tax benefits mirror actual financial risk and reward. Improper allocations could trigger IRS scrutiny or reallocation.

Important considerations:

  • Profit distributions must align with the agreement and be consistently documented.
  • Distributions differ from guaranteed payments, which are fixed amounts paid regardless of profit.
  • Uneven distributions should still reflect the intent of the parties and economic reality.

Properly-Issued LLC Membership Interests

When members' interests are allocated correctly, the following should be fulfilled:

  • First of all, LLCs must produce a written and signed Operating Agreement that sets out the members' interests.
  • These membership interests can be conveyed as percentages. For example, four members may have a 25 percent interest.
  • Members' interests can also be conveyed as units. These are comparable to shares in a corporate structure.
  • An Operating Agreement should also set out the payment that will be paid for members' interests in the LLC.
  • Generally, this consideration is in the form of a cash payment. But it is possible for it to also exist as an alternate benefit, for example, the relocation of assets or supplying of services.
  • The type of consideration is decided according to the Operating Agreement and the specific state regulations.
  • Secondly, proof that each member has paid the required consideration must be shown.
  • Third, an LLC must keep and maintain a record book that files the LLC's crucial documents.
  • This book must contain the company document submitted to the Secretary of State and Operating Agreement. 

Amending Ownership and Profit Splits Over Time

As businesses evolve, so too might the need to revise ownership or how profits are shared. Any change in these areas should be handled with legal care.

Steps to Modify Ownership or Allocations:

  1. Amend the Operating Agreement: Include the new terms of ownership and distribution.
  2. Obtain Member Consent: Most states require unanimous or majority consent for ownership changes.
  3. Document New Contributions or Withdrawals: Whether capital or services are involved, record the new arrangements.
  4. Update Internal Records: Maintain accurate ownership ledgers and official records.
  5. File with the State if Required: Some states mandate updates to member information in public filings.

Note: Transferring ownership may also require compliance with state securities laws.

Consideration Requirements

When the consideration is cash, there is a requirement of documentation of the detailed sum. The documentation must show that the amount has been transferred to the LLC's bank account. If it is a non-monetary consideration, a written agreement between the member and the LLC must be signed. In the agreement, the member must state the detailed consideration. 

Tax Implications of Ownership Splits and LLC Divisions

Splitting or restructuring LLC ownership can have significant tax consequences. For example, the way members share profits and losses impacts how the IRS taxes them individually.

Key Tax Considerations:

  • By default, the IRS treats multi-member LLCs as partnerships and single-member LLCs as disregarded entities.
  • Allocations not based on ownership must follow substantial economic effect rules to be respected.
  • Guaranteed payments to members are subject to self-employment taxes.
  • A change in ownership of 50% or more can trigger a technical termination of the LLC under former IRS rules (less applicable post-2017 but still relevant in some scenarios).

If you divide an LLC into separate entities, the form of division matters:

  • A statutory division (recognized in a few states) can result in two or more separate LLCs with distinct tax treatment.
  • A drop-and-merge method, where assets are contributed to new LLCs and spun off, can have different tax impacts.

Seek tax counsel before executing complex ownership changes to avoid unintended liabilities or IRS audits.

Frequently Asked Questions

1. Can LLC ownership be split 70/30 or other unequal percentages? Yes. Ownership percentages can be divided in any way the members agree upon, regardless of investment amounts, so long as it's documented in the Operating Agreement.

2. How is profit split if one member contributes money and the other contributes labor? LLCs can allocate profits in any agreed manner, even if it differs from ownership percentages, as long as the arrangement meets IRS standards for substantial economic effect.

3. Do I need to report changes in ownership to the state? Often, yes. While not every state requires this, many do. You may need to amend your Articles of Organization or file updated member information.

4. How do I change an LLC’s ownership structure later on? Amend the Operating Agreement, get member approval, and update official documents and state filings. It’s recommended to work with a legal professional to ensure compliance.

5. Can a member sell their ownership share? Yes, but the sale must comply with the Operating Agreement and applicable state laws. New members typically must be approved by existing members.

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