Many feel LLC profits should be based on percentage of member shares, but that’s not always the case. The true distribution method should be spelled out in the operating agreement.
The Standard Method
In most cases, the members (owners) of a limited liability company will distribute profits based on the amount of membership shares owned. The membership shares represent a percentage of how much money each member invested.
For example, LLC and profit distributions for a two-member LLC where one owns 60% of the shares and the other 40%, if the profit were $1,000, the first member would receive $600 and the second $400. This is the most common type of LLC profit distribution method; however, it’s not always utilized.
LLC Operating Agreements
Similar to corporate bylaws, operating agreements are utilized in an LLC (you can find a sample operating agreement in our Media Gallery). In these agreements it must specifically state how profits and distributions will be handed to each member in the limited liability corporation.
It is within the operating agreement where the standard LLC profit distribution method can vary. For example an operating agreement may state that all dividends or money offered to members throughout an accounting year must be equal, and the profits at accounting year end must be divided by the percentage owned by the member. This LLC distribution method can also be reversed where dividends are based on percentage owned and profits are equally distributed.
Accounting for Losses
For accounting purposes, a contributions account is kept for each member in an LLC. This account consists of initial investment, dividends paid out and contributions made (monetary or otherwise).
In an LLC, while dividends may be distributed throughout the accounting year to the members, it’s not a generally accepted accounting principle (GAAP) to offer any profit distributions if there is a loss in any given year.
Some LLCs will set a time period until profits can be distributed. If a business is newly formed as an LLC and doesn’t expect to make a profit in its first year, they may outline in the operating agreement that LLC profit distributions will be made after three years of consecutive business. This can allow for the initial year to garnish a loss and then the two subsequent years, hopefully a profit. The loss from the initial year is subtracted from the profits from second consecutive years and that is the true amount for LLC profit and distribution to each member.
The limited liability company’s operating agreement may rule the LLC’s profit distributions and dividends; however, in an LLC, dividends (not distributions of profit) do not have to be equal as they must be in a Subchapter S Corporation.
For example, one member may donate a vehicle to the LLC for company use and the fair market value of that vehicle is added to that member’s capital account. If the member decides they wish to take back the vehicle, unless specified otherwise in the operating agreement, the member reaps the rewards of having the vehicle returned. This does not mean that the other members of the LLC are offered a dividend in the same amount as the fair market value of the vehicle.
While it’s often simple to decide on LLC and profit distributions (if there is a loss, no distribution), in LLCs the request for dividend payouts are often the most common reason for argument between LLC members.
If you plan on forming an LLC for your entity, you can read the article Cheapest Way to Form an LLC that also includes an operating agreement you can modify to set the laws the members of the LLC must abide by when it comes to dividends and distribution of profits.