In many cases, when a company earns a profit from its business operations, it passes on some of that profit to its owners and investors as a return on their investment. For limited liability companies, this return of profit or other capital among shareholders is called an LLC distribution.
What is an LLC distribution?
An LLC distribution is when an LLC pays out some portion of its capital directly to the business’s owners, also known as LLC members. When an LLC makes a distribution, it is essentially transferring some of its capital on to its members.
The allocation of how a distribution is divided among LLC members is usually outlined in the LLC operating agreement. Typically, each member’s share of any distributions depends on their ownership percentage, also known as their membership interest. Members with larger ownership interests or preferred membership interests receive a larger share of any distributions.
LLC distributions vs. salary
For many LLC members, LLC distributions serve as a replacement for a traditional salary. Rather than paying themselves a regular wage, members simply transfer some of the LLC’s profits from the company’s bank account into their own.
There are a few reasons why LLC members might opt for this approach:
Taxes
Unlike salary payments, LLC distributions are usually not subject to self-employment taxes. Paying LLC members via distributions can thus help reduce the recipient’s overall tax liability.
Schedule flexibility
Unlike salary payments, LLC distributions are not based on a regular payroll schedule. This can make distributions a better option for smaller LLCs whose revenue streams might be seasonal. An LLC can make larger distributions when profits are larger and smaller distributions during quieter times of year.
Financial flexibility
Similarly, paying LLC members through distributions rather than salary allows companies to be more responsive to variations in financial performance. If the LLC does well, members can expect larger payments from their distributions. If the LLC does not perform well financially, distributions will be smaller. Distributions can thus help align financial incentives between LLC members and the overall business.
Multi-member LLC vs. single-member LLC distributions
The mechanisms for taking a distribution are generally similar for multi-member LLCs and single-member LLCs. The primary difference is in calculating how distributions will be allocated among members for multi-member LLCs.
Multi-member LLC distributions
In the case of a multi-member LLC, distributions will typically be divided among members based on each member’s ownership percentage or on their initial capital contributions to the business. In the case of a single-member LLC, all proceeds in a distribution will go to the one member.
Single-member LLC distributions
Single-member LLCs can also be more flexible in terms of scheduling a distribution. The lone member can decide on their own when to take a distribution, while at a multi-member LLC, different members will typically have to agree on when to take distributions. Many multi-member LLCs define when and how they will take distributions in their operating agreement.
How are LLC distributions taxed?
Most LLCs are taxed as pass-through entities, also known as flow-through entities. This means that the LLC itself is not taxed, and any profits or losses instead pass through directly to LLC members. Each LLC member must pay tax on any LLC distributions they receive as part of their personal income tax returns.
However, different types of LLCs can receive different types of tax treatment on their distributions. A CPA or tax advisor can offer more complete guidance for how your LLC should approach its taxes.
Single-member LLC taxes
The IRS treats single-member LLCs as disregarded business entities for tax purposes, meaning that the IRS effectively does not consider the LLC to be a separate entity from its single member. Distributions from a single-member LLC are not taxable events, because the LLC member should already include any profits and losses for the LLC on their own income tax return.
Multi-member LLC taxes
In most cases, the IRS treats multi-member LLCs as partnerships. Distributions are usually not taxable to the LLC itself, and any profits or losses pass through to the members’ personal tax returns.
Even though the IRS treats multi-member LLCs as partnerships and single-member LLCs as disregarded entities, the net effect on how members pay taxes on their share of distributions is often the same. LLC distributions are typically not taxed because they are not considered capital gains.
How often can an LLC make distributions?
There are no federal or state laws governing how often an LLC can make distributions. Many LLCs choose to define their own ground rules by including language in their operating agreement that defines when and how members can take distributions.
Some companies make regular distributions on a quarterly or annual basis, while others do so on a more ad-hoc schedule. In determining the timing and size of distributions, LLC members typically balance their own need for compensation with other business needs, such as growing earnings, covering operating expenses, and retaining cash reserves.
