The Differences in LLC Allocations & Distributions

Organizing your business as a limited liability company, or LLC, gives you corporate-style protection from being held personally responsible for the company's debts without having to go through a lot of the formalities involved in running a corporation. LLC profits are divided among the owners through separate processes called allocation and distribution.

Pass-Through Taxation

A limited liability company is what's known as a "pass-through" or "flow-through" entity for tax purposes. The LLC itself doesn't pay any income taxes on its profits. Instead, the profits "pass through" the company to the owners, who report them as income on their personal tax returns. The share of the profits that each owner reports as income should be specified in the LLC operating agreement. Usually, though, profits are divided according to the size of each owner's stake in the company.

Allocation of Profits

"Allocation" refers to the process of determining each LLC owner's share of the profits. Your allocated share of the profits gets added to your "capital account" in the LLC -- essentially, the dollar value of your stake in the company. Your allocated share is what you report as income on your taxes. Say an LLC has four owners (technically called "members"), who own 45 percent, 35 percent, 15 percent and 5 percent of the firm, respectively, and the LLC reports $100,000 in profit in a given year. Under a typical allocation, the first owner would be responsible for reporting $45,000 of the profit on his personal income tax return. The second owner would be responsible for reporting $35,000, and so on. If the company suffered a net loss rather than a profit, that loss is allocated the same way, with each member getting a portion of the loss as a write-off.

Profits Vs. Cash

Owners of an LLC must report their share of the profits as income on their tax returns regardless of whether they actually receive any of those profits as cash or in some other form. An LLC that posts a $100,000 profit for the year might decide to hold onto some or all of that profit -- to reinvest it in the company, for example, or just keep it around for a rainy day. In that case, the owners might receive less than their allocated share of the profit, or even nothing at all. Nevertheless, they will be taxed the same as if they received their entire allocated profit in cash.

Read More: How Are Profits Split in an LLC?

LLC Distributions

"Distributions" occur when the LLC actually distributes cash or property to the owners. As long as distributions are proportional to each owner's allocated share of the company, then LLC distributions generally aren't subject to tax. That's because the members have already reported and paid taxes on all company profits. Distributions are treated as a return of the capital the owners have invested in the company. However, when distributions are out of proportion to the owners' stake in the company, this can have significant tax ramifications. In such cases, companies would be well advised to work with an accountant or tax professional experienced in LLC matters.

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