A distribution from a Limited Liability Company (LLC) is a payment of cash or property made by the LLC to its owners, known as members. While state laws provide certain default rules, LLC members can use the LLC’s operating agreement to specify how and when profits are allocated, distributed, and taxed.
Distribution Method and Timing
Under the default rules of most state LLC statutes, an LLC is not obligated to make any distributions to its members before they withdraw or the LLC is dissolved. It is advisable for LLC members to create an operating agreement that outlines the method and schedule of distributions. These distributions can be made regularly, such as monthly, quarterly, or annually, or based on specific events like the sale of assets or the liquidation of a member’s interests.
When deciding the timing and size of distributions, it is essential to balance the compensation needs of the members with the business’s needs to grow earnings, cover expenses, and maintain sufficient cash reserves. Often, distributions are made to allow members to pay taxes on the LLC’s profits, as LLCs are generally pass-through entities, meaning members must pay taxes on LLC profits regardless of whether they receive a distribution of those profits.
Proportionate versus Disproportionate Distributions
Distributions can be made in proportion to each member’s ownership percentage, which is usually based on their capital contributions. However, this is not a requirement. State LLC laws may default to equal income distributions among members, regardless of investment size, but this can be altered in the operating agreement.
Profit Allocations versus Profit Distributions
It’s important to distinguish between profit allocation and profit distribution in an LLC:
- Profit allocation refers to how profits and losses are divided among LLC members, regardless of actual payments made to them.
- Profit distribution is the payment made to each LLC member in cash or property from the LLC’s profits.
Regular profit distributions may be necessary for members to cover tax liabilities on their allocated profits.
Recordkeeping
Accurate recordkeeping of distributions is crucial. This includes maintaining copies of payment checks or bank transfer printouts with other business accounting records such as financial reports, cash flow statements, accounts receivable, payroll, and tax documents.
LLCs should also maintain capital accounts to track each member’s initial investments, subsequent contributions, distributions received, and profit shares. A capital account is not a physical bank account but a recordkeeping tool that serves as a ledger. Detailed recordkeeping is important for tax purposes and when a member leaves or the LLC dissolves.
Schedule a Consultation
From initial investments and fundraising to profit allocations, distributions, tax election status, and recordkeeping, LLCs have numerous financial aspects to manage. Professional assistance can ensure your business operates smoothly. Contact the Law Office of David Standridge today to schedule a consultation with our small business attorneys.
Law Office of David Standridge
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Lakewood Ranch, FL 34202
Phone: 941-770-3241