LLC Profits and Disbursement Rules

By Christine Funk, J.D.

LLC Profits and Disbursement Rules

By Christine Funk, J.D.

When a limited liability company (LLC) makes a profit, it may disburse the profits to its owners, called members, or retain the profits for use furthering the interests of the business. Every business chooses when and how to distribute profits.

Coworkers sitting around a table

Distribution of Profits Among Members

Members may distribute profits any number of different ways depending on the needs and desires of the company. One approach to profit distribution is waiting until the end of the year. Then, profits are distributed among the members in shares reflecting the percentage each person owns. In a two-person business with 50 percent ownership by each member, $100,000 in profits divides into disbursements of $50,000 for each. However, in a four-person LLC with the same profits and 30 percent, 25 percent, 25 percent, and 20 percent membership interests, the distribution reflects $30,000, $25,000, $25,000, and $20,000 respectively.

Monthly distribution provides another alternative approach. This approach estimates yearly profits, divided by 12. In a situation where the business expects $120,000 in profits, two equal members may take a monthly draw of $5,000 each. If profits total $150,000 at the end of the year, each member is then entitled to an additional $15,000 in disbursements.

An LLC also distributes profits when it disbands. In this situation, its first obligation is paying off any debts. Next, the company returns any invested capital to the members who invested. Finally, the members receive the remaining assets.

Equal vs. Unequal Distribution

When an LLC has two or more members, both contributing equally to the success of the business, profit distribution should reflect an equal disbursement. "Equal contribution" does not mean "identical contribution," however. Perhaps one member is the chef, while the other manages the front of the house for a restaurant. The work of both is necessary for the success of the business. Assuming each puts in a similar amount of hours and effort, this entitles each member to similar disbursements.

When there are two or more members , but only one actively works advancing the goals of the company, profit disbursement may reflect their unequal contributions. In this case, the profit disbursement for the person working actively for the company may reflect the extra work, which results in the additional profit.

One limit on the distribution of profits is the obligations of the LLC. Most states require that such businesses maintain the ability to pay debts that come due in the ordinary course of business. Consequently, the company may not distribute profits if those profits are the only funds available to pay for things such as rent, phone bills, equipment costs, and the like.

Payments That Are Not Distributions of Profits

If an employee/member takes a salary, this is not a draw of profits. Instead, a salary can be deducted from the profits earned. However, one's salary must be reasonable and commensurate with what others in the field make. Of course, a salary is income, and therefore taxable.

An LLC may also hire a member as an independent contractor. The independent contractor would be paid as any other independent contractor. This requires filing a Request for Taxpayer Identification Number and Certification (Form W-9) with the Internal Revenue Service. Additionally, the company must file Miscellaneous Income (Form 1099-MISC) at the end of the year. Separately, members report the losses or profits on their personal federal tax returns.

If you maintain an LLC with two or more members, and want to learn more about how profits are distributed, keep this information in mind. Being well-informed will help you properly oversee and maintain the distribution of your company's assets.

 

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