Let’s talk about the basic essentials of LLC ownership, LLC distributions, and contributing capital.
LLC ownership is an exciting prospect for many entrepreneurs. But all the terms can feel overwhelming: distributions, capital contributions, membership, taxation, and more. In this guide, we’ll cover all the basics of LLC ownership so you can run your LLC with both confidence and compliance.
Limited liability companies (LLCs) are very flexible business structures, so an LLC owner (also called a member) can be virtually anyone. In most states, LLC owners must be individuals 18 years of age or older. But sometimes, a corporation or another LLC can even be a member of an LLC. An LLC can have just a single member or even hundreds of members. In some states, you’ll include this information on your Articles of Organization.
LLC members usually gain ownership within the company by contributing capital to the business (though some LLCs have different arrangements for gaining ownership, such as putting in additional work). In exchange, they enjoy a share of the profits — and sometimes even management privileges.
In most cases, how much of the profits the members earn and their right to help run the business depends on how the ownership is divided in the LLC. But with LLCs, the members can also make different arrangements if they spell them out in the LLC’s operating agreement. For example, a member with 50% ownership might agree to take only 30% of the profits in exchange for having to do less of the everyday work for the company.
By the same token, management of the company and voting rights don’t have to be reflected in ownership percentages, either, though they often are. Again, the members can make their own arrangements as long as they write them all down in the operating agreement and all sign the document.
LLCs have the luxury of flexibility, so ultimately LLC ownership is defined by the LLC’s operating agreement (much like a constitution or charter). In the agreement, the LLC itself gets to set out each owner’s stake in the business, how members can be added or removed, transferring membership, how the LLC is managed, and more. The two most crucial components are arguably the LLC’s ownership structure and ownership percentages.
If you need help drafting an operating agreement, our customizable, guided operating agreement template can help.
There are two common ownership structures for LLCs: a single-member LLC and a multi-member LLC. A single-member LLC is a limited liability company with a single business owner. Meanwhile, a multi-member LLC has multiple owners. And the operating agreement always dictates how to remove or add members down the road.
In multiple-member LLCs, the members can actually decide how much decision-making power each member has. For example, some LLCs might have two members that equally share responsibility for running the LLC, acting as a member-managed LLC. A different two-member LLC might have one member run the business while the second acts as more of a silent investor. Another LLC’s members might hire managers to run the business so they can be a manager-managed LLC. In these LLCs, members might assign different owner titles to convey their roles.
The real luxury is that the LLC’s members can set their own management structure in their operating agreement. It’s one of the many benefits of running an LLC.
Another aspect of LLC ownership is the ownership percentage of each member. In most LLCs, ownership matches the amount of capital each member contributes to the LLC. For example, let’s say that three business partners team up to create an LLC. One member contributes $50,000, and the other two contribute $25,000 a piece to help get the business up and running. The first member would own 50% of the LLC and the other two members would own 25% each. In this scenario, an LLC’s ownership resembles a corporation. But, as mentioned earlier, the ownership percentages don’t have to be dictated by capital contributions.
Unlike a corporation, the voting power of the LLC’s owners doesn’t have to match their ownership percentages. The LLC can decide how much say each member has. For example, maybe the 50% owner doesn’t want to run the day-to-day affairs of the business; they just want to invest and enjoy a share of the profits. The other members would handle the daily management responsibilities.
An LLC’s operating agreement should clearly define the ownership percentages, voting rights, and structure of the business.
Capital contributions are investments that the LLC receives, often brought by the members. Often, capital contributions are cash assets, but sometimes members can contribute property and equipment for the LLC to use. The operating agreement should describe the monetary value of all assets each member contributes. It will also describe what happens to those assets if a member ever leaves.
There are three different types of contributions that LLCs can receive: equity investments, debt investments, or convertible debt.
An equity investment is an investment given in exchange for a share of ownership of the LLC. Anyone who contributes an equity investment receives a share of the business profits. Depending on your operating agreement, they may also be entitled to help make business decisions. But since they get a share of profits, you won’t have to repay these investments.
Most starting members of an LLC bring an equity investment.
A debt investment is a very common investment type for new businesses. They’re loans, usually requiring the LLC’s members to put up some sort of collateral. Sometimes you can get a loan without putting up collateral, but it’s uncommon and usually results in a smaller loan. Even though paying back a debt can be stressful, it allows you to raise some additional capital without changing the LLC’s membership.
Convertible debt essentially combines the other two types of contributions. If an LLC takes a convertible debt loan, they either promise to repay the debt or convert the money they owe into an ownership stake in the company for the lender. This contribution type gives an LLC a little flexibility for repayment.
After the LLC uses its capital contributions to get started, they’ll eventually make distributions. Distributions are the way LLCs pay their members from their profits. But when you make those distributions depends on two things: the LLC’s distribution schedule and your taxation structure. You’ll get to set your own distribution schedule in your operating agreement, and you get to choose which taxation structure you’ll have.
There are three key taxation structures: a pass-through entity, a C corporation, or an S corporation. Your structure will affect whether your LLC makes distributions before or after paying taxes. Making these distributions compliantly helps protect your personal liability.
By default, the IRS considers both single-member and multi-member LLCs to be pass-through entities. The LLC itself doesn’t pay taxes; instead, it’s a separate entity that distributes its net profits among its members. The members report that income on Schedule C of their personal income tax returns. Usually, this process repeats on the state level.
In short, a pass-through taxation LLC makes distributions before taxes.
LLCs can elect to be taxed as a C corporation instead. If they do, the LLC itself will be taxed as a separate business entity, paying corporate income taxes on their profits before making distributions to its members. Then the LLC’s members will pay personal income taxes on their distributions. Tax professionals refer to this as double taxation. It might sound harsh, but in some cases, C corporation status can give certain tax breaks.
Electing S corporation status only applies to certain LLCs, but it allows an LLC to blend an LLC’s pass-through taxation with some of the tax breaks of a corporation. In particular, an S corporation’s members can deduct losses (even on their personal return) and deduct qualified business income. Since the LLC itself won’t pay taxes on its income, the distributions are made before any taxes are paid.
We highly recommend consulting with a tax professional to discuss which option is right for the unique ownership structure of your LLC.
Whether you’re forming an LLC by yourself or with a full team, it doesn’t have to feel overwhelming. At ZenBusiness, we’ve got your back. Whether you need a zero-cost formation service, registered agent service, or guidance writing an operating agreement, we’ve got you covered. We’ll handle the paperwork steps so you can focus on what matters: making your business succeed.
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.
What percentage of your business profits do you feel you need? Many LLC owners pay themselves through distributions regularly to act like the salary they’d get from a “regular job.” But generally speaking, you don’t have to distribute 100% of your profits to your members if you don’t want to. For example, you might take some of your profits to reinvest them in new equipment for the LLC, or you might want to have a small cash surplus on hand in case of an emergency. Regardless of whether the profits are distributed, though, each member is still responsible for paying income and self-employment taxes on their share of the profits.
If an LLC’s member contributes capital property to the business, it can be a little tricky to quantify how big their ownership stake is. That’s why you should take the time to get an estimated market value for each non-cash asset that’s contributed.
You should include this value in your operating agreement. The agreement will put in writing when personal assets of members become business assets, how much those are worth, and what happens to them if the contributing member leaves the business.
In most cases, an owner of an LLC (usually called a member) is anyone who has an equity investment contribution in an LLC. These contributions aren’t always equal, and LLCs can have different approaches to which owners can make management decisions for the business.
LLC owners are commonly called members.
All distributions from an LLC are considered income, and as a result, they’re taxable. How much you’ll pay in taxes on those distributions will largely depend on your income from other sources. If you’re taxed as a pass-through entity, you’ll pay taxes through your personal tax return (the default status for LLCs). If you’re taxed as a C corporation, the business will pay taxes on the profits and you’ll also pay taxes on the profits when they’re distributed to you, which is called “double taxation.”
When you receive an LLC distribution, it’s a good idea to do some calculations before you start spending. You will owe taxes on that income, and you’ll have to pay quarterly estimated tax payments if you want to avoid a late fee. You can calculate how much you’ll owe in taxes based on your projected income; we recommend consulting with a licensed tax professional to get some help with this.
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