LLC Profit Distribution

LLC profit distribution isn’t the most straightforward aspect of running a limited liability company (LLC), but it doesn’t have to be insurmountable. If a business owner knows what to expect, they’ll be pretty prepared for paying their members.

This guide covers the essentials of LLC distributions, including the basics of the process, how the 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 a single member if there’s only one owner). These distributions are how LLC owners get paid. Distributions from an LLC are a little bit different from corporate dividends. Dividends are paid to a corporation’s shareholders after the 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 profits 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 C corporation tax election, which is uncommon).

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 weren’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 for the year, 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, consider a two-member LLC. Suppose each member invested $10,000 in their LLC, so they would likely have equal ownership and split 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, suppose 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 of the LLC structure is that the 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 the 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 the LLC to be unable to pay its normal debts or liabilities, such as bank loan repayments or rent.

From a practical standpoint, an LLC’s distributions shouldn’t come from the net capital in its bank account. Distributions should come from the LLC’s projected or actual capital gain. They’re typically cash distributions, but they don’t 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 an LLC owner’s business routine, but that doesn’t mean the members can get complacent about them. Each time the LLC makes a distribution, there are several key tasks to keep track of.

Carefully document each profit distribution

Whenever an LLC distributes money to its 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 it was distributed (e.g., check, direct deposit, bank transfer).

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 the LLC’s distributions.

Communicate transparently for each profit distribution

The LLC’s operating agreement will dictate how and when the 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.

ZenBusiness can help!

Starting and managing an LLC can feel like an overwhelming prospect, but entrepreneurs don’t have to navigate it alone; ZenBusiness is ready to help. Their operating agreement template can help LLC members set out exactly how they want distributions to work. And ZenBusiness Money Pro makes it easy to track every invoice, expense, paid receipts, and more. ZenBusiness can even help entrepreneurs start their first LLC for $0 plus state fees. ZenBusiness supports entrepreneurs so they can focus on what matters most: running the business successfully.