How Is a Cash Dividend From an LLC Taxed?

When the owners of a limited liability company receive cash distributions of company profits, their tax responsibility depends on the company's own tax status. If the LLC is treated as a so-called "pass-through" entity by the Internal Revenue Service, then these distributions don't trigger extra tax. If the IRS treats the company like a corporation, though, distributions get taxed as corporate dividends.

Because LLCs are organized under state statutes rather than federal law, the Internal Revenue Service doesn't recognize them as a distinct form of business. Instead, it treats an LLC as either a sole proprietorship or a partnership, depending on how many "members" -- that is, owners -- the company has. If the LLC has just one member, the IRS will treat it like a sole proprietorship. If it has multiple members, the IRS treats it like a partnership. Any LLC also has the option of being taxed like a corporation; the company files a form with the IRS to request corporate tax status.

Both sole proprietorships and partnerships are pass-through entities for tax purposes. That means that the businesses themselves don't pay income tax. Instead, all profits "pass through" the company to the owners, who report those profits as income on their personal tax returns. In sole proprietorship and single-member LLCs, the one owner reports all the profits as income. In partnerships and LLCs treated as partnerships, the profits get allocated according to percentage of ownership. If you have, for instance, a 35-percent ownership stake in an LLC, and the company has $10,000 in profit, then you will report and pay taxes on $3,500 worth of income.

A critical point to understand with pass-through taxation is that you have to pay taxes on your share of the company's profit regardless of whether you actually receive any cash from the company. If the LLC were to take its $10,000 profit and reinvest it in the business, a member with 35-percent ownership would still be on the hook for $3,500 in taxable income. On the other hand, if you do actually receive a cash distribution of LLC profit -- sometimes called a dividend -- you don't have to pay taxes separately on the cash you get. That's because the money is already accounted for as your share of the pass-through profit you must pay taxes on.

The rules are different if your LLC has requested corporate tax treatment. Being taxed as a corporation makes sense for an LLC that reinvests a significant portion of its profits, because that way the members aren't carrying a heavy personal tax burden for profit that they don't receive. Under corporate status, the LLC itself pays corporate income taxes on its profits, and the owners bear no tax liability for those profits, but distributions of after-tax profit to the members are treated like corporate dividends. The members report them as income and pay taxes on them, but they only report the cash they actually receive.