Distributions to LLC Members vs. Dividends

By Laura Payet

Distributions to LLC Members vs. Dividends

By Laura Payet

Although members of a limited liability company (LLC) and corporate shareholders both have ownership interest in their respective companies, they profit from that interest in very different ways and face very different tax consequences. Distributions to a member reflects that member's share of the company's profits, and a dividend paid to a stockholder is essentially a premium or reward that shareholders sometimes receive when the corporation has sufficient earnings or excess cash on hand.

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Distributions to LLC Members and Tax Requirements

LLC members receive distributions from company earnings based on their individual investment in the company and on the terms outlined in the company's operating agreement. The operating agreement establishes how the company is managed and how it shares its revenues and liabilities. It also describes each member's share of earnings and when to make distributions. They profit from their investment as the company's earnings increase. Each member has a legal claim on the company's earnings, but an individual cannot force a distribution inconsistent with the operating agreement unless all the members agree. Law generally allows an LLC to retain its profits and not distribute them to the members unless the operating agreement says otherwise. Additionally, this legal business entity may not make distributions if they would hamper its ability to meet its ongoing obligations, or if immediately after the distributions, the company's debts exceed its assets.

An LLC is a pass-through entity; the company itself does not pay income tax on its earnings. Rather, those earnings pass through to its members, each of whom must report their share on their personal income tax return and pay personal income taxes on that share. They must pay taxes on their portion of the company's income even if they receive no distributions from the company in a tax year. If a member receives a distribution from income on which they have already paid tax, that distribution is not taxed further.

Shareholder Dividends and Tax Requirements

Shareholders, like LLC members, own a portion of the corporation in which they hold stock. However, unlike LLC members, shareholders have no legal claim on a particular share of company profits. In fact, shareholders of common stock have no entitlement to a dividend at all (although shares of preferred stock may guarantee one). Rather, the corporation's board of directors has discretion to declare a dividend, which they may choose to do if the business has had a particularly successful year or has excess cash on hand. In most cases, a shareholder expects to profit from their investment in the corporation not by receiving dividends but by an increase in the shares' value as the business succeeds.

Unlike an LLC, a corporation is not a pass-through entity. A corporation pays income tax on its profits. When a shareholder receives a dividend, that shareholder pays taxes on it. Generally, dividends are taxed as ordinary income, but in some circumstances, they may be eligible for capital gains treatment. In contrast to an LLC member, who must pay tax on the company's income even if they do not receive a distribution, a corporate shareholder is not liable for tax on the corporation's profit and is only liable for tax on dividends received.

If you are an entrepreneur looking to start a new company, an LLC may be a good fit for your business, because it offers the same protection from personal liability for its owners that a corporation does while avoiding the double taxation corporate profits are subject to and bypassing some of the formalities a corporation must observe.

This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.