How Are Profits Split in an LLC?

By Terry Masters

One of the significant benefits of organizing a company as a limited liability company, called an LLC, is the ability to allocate profits according to the needs of the owners, rather than by the number of shares of stock a person holds. LLC owners, known as members, can choose to split up profits any way that works for them, as long as they elect to be taxed as a partnership.

Type of Entity

The IRS does not have a dedicated tax category for the LLC. Instead, it requires multiple-member LLCs that need to split profits to choose whether to be taxed as a partnership or a corporation. The most common choice is to be taxed as a partnership, because a company that wanted corporate tax treatment would simply form a corporation. An LLC that is taxed as a partnership is a disregarded, or pass-through entity meaning profits and losses are passed through to members for inclusion on individual tax returns instead of being taxed at the business level. A pass-through entity maintains a capital account for each member, and profits are split by allocating amounts to this account. A member's capital account equals the value of his contributions, plus allocated profits, minus allocated losses, minus distributions.

Allocations

In a partnership LLC, profits are split annually at the end of the company's fiscal year. Splitting up profits between members is called an allocation. Profits and losses are allocated by default in the same ratio as each member's ownership interest. A member's ownership interest is initially equal to his capital contribution. So if an LLC has two members, and one contributed $25,000 to start the company and the other contributed $75,000, the first member would be allocated 25 percent of the profits. This method of allocating profits and losses is the default method established by the state law under which the LLC is formed. Each member's ownership interest is initially equal to the opening value of his capital account. Over time, further contributions, allocations and distributions into the capital account might change a member's ownership interest and percentage of the profits.

Ready to start your LLC? Start an LLC Online Now

Special Agreements

The default provisions of state law that mandate allocations of profits to members applies only in the absence of an agreement between the members. One of the benefits of the LLC is its flexibility in designing an owner profit-and-loss structure. By adopting an operating agreement, the members can decide to allocate profits or losses in a proportion that is not equal to the members' ownership interests. This may apply if certain members made their initial contribution to the LLC as cash, while other contributed services. The members might agree that the members who contributed cash will receive a high percentage of the profits until that initial cash contribution is paid back.

Other Considerations

The allocation of profits in LLCs can turn into a complex accounting matter. Special circumstances can change the way profits are allocated. For example, the tax code makes a distinction between active and passive members, or members who work for the LLC versus those who don't. The active member can receive early distributions of profits as a salary. If the LLC's profits at the end of the year come from ordinary sales and revenue, the active member gets to keep his salary, and the balance of the profits are divided up in proportion to ownership interest. If the profits are derived from capital transactions, such as the sale of real property, the salary payments are treated as part of the member's total profit distribution, decreasing the amount he will get out of the pot as his share at the end of the year.

Ready to start your LLC? Start an LLC Online Now
What Equity Accounts Should I Have for an S-Corp With Two Partners?

References

Resources

Related articles

Does an LLC Need to Place a Value on Each Membership?

An LLC should place a value on each membership. A membership interest is the value of all of the rights enjoyed by LLC owners, called members, including their monetary investment, voting rights and ability to share in the LLC's profits. A member's interest is based on the value of the company as a whole. Two popular methods are used to establish an LLC's value, and a member's interest is then valued by the conditions and percentage of his membership.

Regulations for Limited Liability Companies

Limited liability companies, or LLCs, are versatile business vehicles that were designed to take advantage of some of the best features of both corporations and unincorporated entities. Since LLCs are created under state law, regulations governing LLCs vary somewhat from state to state. Nevertheless, the basic principles governing LLCs are the same in every state.

S Corporation Structure

An S corporation is a tax designation that a business must apply for with the Internal Revenue Service. Used for small businesses, the benefit of the S corporate designation is that it allows the business to be taxed as a partnership. To apply for S corporate status, the business must submit a completed Form 2553 within 2 months and 15 days after the beginning of the first tax year that it wants to be treated as an S corporation.

LLCs, Corporations, Patents, Attorney Help

Related articles

LLC Vs. S Corp Profit Sharing

A limited liability company, or LLC, and S corporation are both popular business structures that usually protect their ...

How Do Capital Accounts in LLCs Work?

An LLC's capital accounts allow the company to maintain an accurate accounting of each member's contributed cash or ...

Sweat Equity and the S Corporation

Various contributions are made to startups and small companies by their owners in the form of cash, property and ...

Why Choose an LLC?

The LLC is a form of business organization that combines elements of corporations and partnerships. It is designed to ...

Browse by category
Ready to Begin? GET STARTED