Members of a limited liability company, or LLC, and the shareholders of a corporation are similar in that they each hold all ownership interests in their entity’s underlying business. As owners, members and shareholders have an expectation of monetary gain on their investments, but they receive them in different ways. The members of a LLC receive distributions of profit, whereas the common shareholders of a corporation can receive dividends.
For the common shares of corporate stock that trade on a public stock exchange, there is no guarantee that shareholders will receive dividends. The declaration of a dividend by a corporation is at the discretion of the company’s board of directors. Generally, a corporation will not declare a dividend unless it has accumulated earnings or is highly profitable in the current year. Instead, the main source of investment gain for common shareholders is the increase in share value, which is a result of the corporation’s profitability and growth. However, corporations can offer investors the opportunity to purchase preferred shares of stock that guarantee the payment of dividends. Preferred shares also provide shareholders with a superior claim to dividends over common shareholders.
LLC Member Distributions
Members of a LLC don’t own shares of stock in the business. Instead, they obtain ownership interests in the LLC that entitle them to a certain percentage of business profits, which in most cases is in proportion to the amount of their capital contribution to the firm. The initial members of a LLC draft an operating agreement that dictates how and when the company will make profit distributions to members. States don’t impose any limitations on what the operating agreement can include, provided it doesn’t violate state law. As a result, there is never a guarantee that members will receive a distribution each year. However, despite that members are subject to the terms of the operating agreement and have no authority to require a profit distribution, they always retain a legal claim on their proportionate shares of profits that the LLC fails to distribute.
The federal tax implications of LLC distributions and corporate dividends are quite different. Preferred and common shareholders must pay income tax on corporate dividends in the year they receive payment. However, since the corporation is a separate taxpayer from its owners, shareholders are never responsible for the income tax on earnings the corporation retains.
LLC Distribution Taxation
Limited liability companies that don’t elect corporate tax treatment are not separate taxpayers. Instead, each member is responsible for reporting his proportionate share of business income on his personal tax return. As a result, LLC members pay income tax irrespective of whether the LLC distributes the earnings or not. However, if a member pays income tax on earnings in the first tax year but doesn’t receive the distribution until the second tax year, no additional tax payments are necessary when the distribution occurs.