LLC profit distribution isn’t the most straightforward aspect to running a limited liability company (LLC), but it doesn’t have to be insurmountable. If you know what to expect, you’ll be pretty prepared for paying your members.
In this guide, we’ll cover the essentials of LLC distributions, including the basics of the process, how your operating agreement comes into play, and pitfalls to avoid.
What is an LLC profit distribution?
An LLC profit distribution is a payment made by an LLC to its members (or single member). These distributions are how LLC owners get paid. Distributions from an LLC are a little bit different from corporation dividends. Dividends are sent to corporation shareholders after a corporation pays taxes on its profits; the shareholders also pay taxes a second time on the taxable gain they receive through dividends. Because of these corporate tax rules, the corporation’s income is subject to double taxation.In contrast, LLC distributions usually happen before taxes. The members pay taxes on the profits they receive without those taxes first being taxed at the business level because LLCs are pass-through entities (they’re taxed like partnerships or disregarded entities for single-member LLCs). So while dividends are taxed twice, distributions are taxed only once (unless the LLC makes a What is a C corporation? tax election).
Tax Implications of Profit Distributions for LLC Members
When it comes to LLC profits and taxes, there’s an important distinction to make: profit allocations of the LLC and profit distributions. A profit allocation is the portion of the LLC’s income that’s assigned to one particular member by the operating agreement. In contrast, a profit distribution is how much the LLC’s members actually receive to their personal bank accounts. Profit allocations and profit distributions aren’t always equal.
An LLC’s member owes income taxes on their allocation of profits — not their actual distributions. If this wasn’t the case, LLCs could basically avoid their tax liabilities by never making distributions. Instead, each year the LLC’s members will pay personal income taxes on their allocated profits, even if they haven’t received all of their distributions yet.
How Profit Distributions Are Determined Among Members
Most often, an LLC’s distribution of income is governed by the ownership percentage of each member. For example, let’s consider a two-member LLC. Each member brought an initial investment of $10,000 into their LLC, so they would probably have equal percent ownership and split their profits 50-50. But an LLC doesn’t have to distribute profits that way. Some LLCs might allocate a larger share of profits to a member who does more work. Other LLCs might make a few special allocations to pay back one member’s initial investment before making standard allocations.
For example, let’s say one member handles the weekend shifts and the other takes all the weekday shifts. The members might agree to split profits 30/70 to reward the second member for their heavier workload even though their actual ownership percentage is the same. The luxury is that the LLC members get to set terms that work best for their needs.
Role of an LLC’s Operating Agreement in Governing Profit Distributions
The operating agreement is one of the most important documents a multiple-member LLC will ever create. An operating agreement acts like a constitution or charter for the LLC; it governs how the business entity will operate. And that includes distribution provisions.
A well-drafted operating agreement describes how much profit each member will receive, what their initial capital contribution was, and when and how profits will be distributed. By setting out this procedure in advance, the LLC protects itself from future disputes and legal issues. If an LLC doesn’t have an operating agreement in place, it will be governed by the default rules from its state’s limited liability company statutes. (For more information, please see our operating agreement definition page.)
Legal Requirements and Regulations for LLC Profit Distributions
Every state has slightly different statutes for LLCs, especially those that don’t use the Uniform Limited Liability Company Act. But generally, there are several common regulations for profit distributions. Here are some guidelines to keep in mind:
- Distributions must be made in accordance with the LLC’s operating agreement.
- Distributions cannot cause your LLC to be unable to pay its normal debts or liabilities, such as bank loan repayments or rent.
From a practical standpoint, your distributions shouldn’t come from the net capital you have in your bank account. Distributions should come from your projected or actual capital gain. They’re typically distributions of cash, but they don’t always have to be.
Impact of Profit Distributions on the LLC
Profit distributions impact the LLC and its members in several ways. Once money is distributed, it no longer belongs to the LLC; it belongs to the members. So the entity’s bottom line is affected. If the LLC needs to purchase new equipment or property, the members might decide to forgo a distribution until later (depending on what their operating agreement says).
Additionally, it’s important to remember that if members approve a distribution that’s prohibited, the individual members can be held liable for that amount. That action can compromise the personal liability protection of the LLC.
Important Items to Keep Track of:
Distributions will probably become a somewhat regular part of your business routine, but that doesn’t mean you should get complacent about them. Each time you make a distribution, there are several key tasks to keep track of.
Carefully document each profit distribution
Whenever your LLC distributes money to the members, the person in charge of the distribution should make careful records. Typically, a good profit distribution record should describe how much money was distributed to each member, when it was distributed, and how the money was distributed (i.e., check, direct deposit, bank transfer, etc.).
A lot of LLCs maintain capital accounts for each individual member. These capital account balances usually start out with each member’s initial investments. But they do change over time as profits are allocated and additional capital contributions come in. Whenever a distribution is made, it’s pulled directly from the members’ capital account balances. Keeping records of this is absolutely essential.
Not only is this information vital for tax time, but it’s also helpful to have on hand if there’s ever a question about your distributions.
Communicate transparently for each profit distribution
Your operating agreement will dictate how and when your LLC can make distributions. For some LLCs, the pre-arranged process for distributions requires all of the members to meet and agree to make a distribution. Another LLC might let the managers decide when distributions should be made.
Whoever is responsible for making the distributions should clearly communicate all the details of each distribution. If a distribution would normally happen but the LLC can’t afford to make one, the members should be told right away. Being fully transparent is the best way to ensure everyone is on the same page — and reduce the likelihood of misunderstandings or hurt feelings.
We can help!
If managing your LLC’s cash flow has you feeling overwhelmed, don’t worry — ZenBusiness has your back. Our operating agreement template can help you set out exactly how your distributions will work. And ZenBusiness Money makes it easy to track every invoice, expense, paid receipts, and more. We can even help you start your first LLC for $0. We’ll support you so you can focus on what matters most: running your business successfully.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
