This is often the first question I get after a client forms a LLC. A distribution from a limited liability company (LLC) is a payment of cash or property made by the LLC to the LLC’s members. Although the Texas Business Organizations Code (TBOC) law sets forth certain default rules, the LLC members can specify in the LLC’s Company agreement when and how profits are allocated, distributed, and taxed. We build these distribution concerns into our Company agreements.
Distribution Method and Timing
Distributions can be made on a regular basis, such as monthly, quarterly, or at the end of the fiscal year; or based on specific events, such as the sale of assets or the liquidation of a member’s interests. Under the default rules provided by most state LLC statutes, a LLC is not required to make any distributions to members before they withdraw from the LLC or it is dissolved. Although TBOC does not require a LLC Company agreement to be a valid LLC, it is prudent for the LLC members to include provisions in a Company agreement that specifies the method and schedule of distributions based upon the purpose of the LLC.
When determining the timing and amount of distributions, the needs of members must be considered alongside the needs of the business. If the goal is to grow earnings, cover expenses, and retain sufficient cash reserves then distributions may be minimal. Often, distributions are made to enable members to pay taxes they owe on the LLC’s profits. Because LLCs are generally pass-through entities, although not exclusively, the members must pay taxes on LLC profits regardless of whether they receive a distribution of those profits.
Proportionate versus Disproportionate Distributions
Distributions are often made in direct proportion to how much of the LLC each member owns—an amount that is typically based on an owner’s capital contribution to the business. This is not required, however. Although TBOC provides a default rule that members must share income distributions equally regardless of how much each member invested, the owners can override this in the Company agreement.
Profit Allocations versus Profit Distributions
Profit allocation and profit distribution are not the same thing in a LLC.
- Profit allocation is how the profits and losses are divided among LLC members, regardless of how much the LLC pays the members.
- Profit distribution is the payment to each LLC member in cash or property by the LLC out of its profits.
As mentioned, LLC members may need to receive regular LLC profit distributions to cover the tax liabilities on their profit allocations.
Note: Members should talk with their professional advisors about the LLC tax election that is most advantageous for their business model.
Recordkeeping
It is very important for the LLC and its members to maintain accurate records of distributions, such as a copy of the payment check or a printout of the bank transfer. This information should be kept with other business accounting records such as financial reports, cash flow statements, accounts receivable, payroll, and tax documents.
Further, to keep track of each member’s interest in the LLC, LLCs should keep records called capital accounts to track their members’ initial investments in the LLC, subsequent contributions to the company, distributions they receive from the LLC, and the percentage of profit attributable to each member according to their membership interest percentage. Capital accounts may also include contributions based upon “sweat equity”.
A capital account is not an actual, physical bank account. It is a recordkeeping account that exists only on paper, such as a spreadsheet, and effectively serves as a ledger. As with all recordkeeping, details matter. Detailed recordkeeping is important not only at tax time but also when a member leaves or the LLC is dissolved.
Call Us Today for an Appointment
From initial investments and fundraising to profit allocations and distributions, tax election status, and recordkeeping, LLCs have a lot of moving financial parts. Professional help can keep your business machine running more smoothly. Please reach out and schedule a meeting with your attorney at Thrash, Carroll & Vanway Law Group to discuss if and how a LLC can help your business grow and protect you and your family’s assets. Our phone number is 512.263.5400 or email us at [email protected] today.
Erin M. Thrash