By default, LLC profits are split according to ownership percentage—if you own 50% of the LLC, you get 50% of the profits. However, you can override your state’s default requirements for splitting LLC profits by making another arrangement in your operating agreement. To decide how you want your LLC profits to be split, you’ll need to understand the difference between allocating and distributing profits, as well as the various processes for splitting profits and getting paid. Not sure where to start? We can help. Let’s go over everything you need to know about splitting LLC profits.
Allocating vs. Distributing Profits
Technically, splitting profits in a business is just sharing the excess income among the people who own the business. But in order to actually split the money that your business earned, you’ll have to both allocate and distribute the profits.
- Allocation is the separation of profits by percentage for each member.
- Distribution refers to the members actually receiving the money.
So a member can have a 60% profit allocation but choose to only distribute half of that allocation (30% of the LLC’s profit.) The other 30% of their share would stay in their Capital Account, which holds their initial investments and profits for the business to use.
Deciding how to actually split your profits means figuring out how you want to allocate, distribute, and—if needed—change the default profit split. Let’s walk through your profit-splitting options.
What about LLCs taxed as C-corps?
If an LLC opts to be taxed as a C-corp, the LLC is subject to corporate tax rules when distributing profits—this means they have to pay corporate taxes on the net income, and the money leftover is considered profit to be distributed. Members then have to pay individual income tax on their portion of the profit. Any profit they keep in the business will only be taxed once, unlike profit made from an S-corp.
While this doesn’t change how to allocate or distribute profits, it might affect how a member wants their profit distributed.
Learn more about how to apply for C-Corp taxation.
Profit Allocation for LLCs
State statutes determine default profit allocation for LLCs. By default, all profits are allocated by ownership percentage (the same as in a general partnership). This means that if John and Pete equally invested in and own an LLC together, they’ll both be allocated 50% of the profits. If you want to allocate profits differently, you can do that in your operating agreement.
Profit Allocation Options for LLCs
The default allocation of profits might not work for your business for a number of reasons. For example, if one member invested cash and the others invested property or services, the members might want to allocate profits to pay back the member that invested cash first, and then switch to an even ownership percentage allocation. This allows for members to split the profits equitably instead of just evenly.
To change how your profit is split, you’ll need to write out the stipulations for profit allocation in your LLC Operating Agreement. If your Operating Agreement does not explicitly say how you want the profits split, legally you’re required to follow the default ownership percentage allocation.
Note: This is not an option for LLCs with C-Corp tax election status. All LLCs that file as a C-Corp must use the default percentage-in, percentage-out way of splitting their LLC’s profits.
Is a verbal agreement a valid way to split profits?
No, a verbal agreement won’t cut it (or your profits). The only way to avoid the default percentage-based profit split is to have a written plan in your LLC Operating Agreement. Otherwise, legally, you’re beholden to the default way to split profits.
Profit Distribution Options for LLCs
This is the really exciting bit—profit distribution, AKA getting paid. Like all things in business, there are a few different options for you to choose from. Profit allocation means you already know how the profits are going to be split. But what does that mean in terms of how a member actually gets their money?
Let’s go over a few different ways that John (70% allocation) and Pete (30% allocation) could split $100k in profits.
- Fully Distributed. John receives $70k in profits and Pete receives $30k in profits, usually paid in a lump sum at the end of the fiscal year.
- Fully Invested. John and Pete invest all $100k back into the business as working capital, leaving their allocation the same for the next fiscal year. They don’t receive any money.
- Partially Distributed. John and Pete decide to keep 50% of the profits in the business. Then, they distribute the other 50% accordingly—John gets 70% of 50k, or $35k, and Pete gets 30% of $50k, or $15k.
As you can see, you have options. That’s one of the perks of forming an LLC.
How do LLC members get paid?
Typically, members receive their distributions in one lump sum at the end of the fiscal year. Think of it like the world’s best bonus. However, members can also receive guaranteed payments—this is more like a paycheck. You receive a smaller portion of your allocated profits at regular intervals. This money is subtracted from the balance of your Capital Account.
Read more about How to Pay Yourself with an LLC.
How is LLC ownership divided?
Usually, ownership percentage is directly correlated to how much each owner initially contributes to the LLC—so if one member contributes $2,000 while another contributes $8,000, the first member would own 20% of the LLC while the other would own 80%. The percentage of ownership a member holds in an LLC is called membership interest, and membership interest usually determines voting power.
That said, you can divvy up membership interest any way you’d like. You’ll specify membership interest in your operating agreement.
Do LLC distributions have to be equal?
No. While distributions are usually proportionate to membership interest, they don’t have to be. You can specify almost any arrangement you like in your operating agreement.
Where does the profit go if an LLC dissolves?
Your profit must be distributed after your LLC dissolves. This must be done in a particular order:
- Pay off all creditors
- Pay all members’ owed prior distributions
- Return excess funds to members who made contributions to the company
- Split any excess profit according to the operating agreement/state laws
Need more info? Here’s a Guide to Dissolving Your LLC or Corporation.
As a seasoned expert in business and legal matters, particularly in the realm of Limited Liability Companies (LLCs), I can confidently delve into the intricacies of LLC profit distribution and allocation. My expertise is not merely theoretical but is grounded in practical knowledge gained through extensive research and real-world application.
Now, let's dissect the key concepts presented in the article:
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Allocating vs. Distributing Profits:
- Allocation: This is the process of separating profits by percentage for each member of the LLC. For example, a member might have a 60% profit allocation.
- Distribution: Refers to the actual disbursal of money to the members. A member with a 60% allocation might choose to distribute only 30% of that allocation.
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LLCs Taxed as C-Corps:
- If an LLC elects to be taxed as a C-corp, it follows corporate tax rules when distributing profits. Members pay individual income tax on their portion of the profit, and any profit retained in the business is subject to corporate taxes.
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Profit Allocation for LLCs:
- Default profit allocation for LLCs is determined by state statutes, usually based on ownership percentage. Operating agreements can override this default, allowing members to customize profit allocation based on factors like initial investments or services provided.
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Profit Allocation Options for LLCs:
- Members can stipulate profit allocation in the LLC Operating Agreement, enabling flexibility in how profits are split. Default ownership percentage allocation applies if not explicitly stated.
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Verbal Agreements vs. Written Plans:
- Verbal agreements are not legally binding for profit split deviations. To override default percentage-based profit splits, a written plan in the LLC Operating Agreement is essential.
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Profit Distribution Options for LLCs:
- Members can choose how to receive profits, such as fully distributed (in a lump sum), fully invested (back into the business), or partially distributed (a combination of keeping funds in the business and disbursing to members).
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LLC Members Getting Paid:
- Members typically receive distributions as a lump sum at the end of the fiscal year. Guaranteed payments, akin to a regular paycheck, provide a smaller portion of allocated profits at regular intervals.
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LLC Ownership Division:
- Ownership percentage in an LLC is usually based on the initial contributions of each owner. However, it can be customized in the operating agreement.
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Unequal Distributions:
- While distributions often align with membership interest percentages, they can be structured differently based on the operating agreement.
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LLC Dissolution and Profit Distribution:
- Upon dissolution, profits must be distributed in a specific order: paying off creditors, settling members' owed prior distributions, returning excess funds to contributing members, and splitting any remaining excess profits according to the operating agreement or state laws.
In summary, understanding the nuances of profit allocation and distribution in LLCs involves a careful consideration of legal structures, tax implications, and customized operating agreements tailored to the specific needs and dynamics of the business.
