In an operating agreement for an LLC do you have to spell out exactly how and when the distributions to members are paid out or do you have to pay out your profits as they are incurred?
Example: Can I state in my operating agreement that I will pay out a certain dollar amount per month, starting on a particular date (i.e. beginning in year 3) until the member’s entire investment has been repaid plus an additional dollar amount (say double what they have paid in) and then can I make a particular date and a particular dollar amount to buy them out?
This way I know my exact cash flow to investors.
I understand that they will pay taxes on the profits of the business, but is that regardless of how much I actually distribute to them (I do know that they won’t pay taxes on return of contribution or basis) or do I need to pay them consistent with the profits of the company in addition to their return of contribution?
Thanks for this forum, these are burning questions.
– Lori, Colorado
You can (and should) definitely spell out in exacting detail in your Operating Agreement how the LLC members will be paid.
Also, a Limited Liability Company that is taxed as a partnership is permitted to distribute cash ‘unevenly’ (an amount disproportionate to the member’s ownership interest).
Remember that an LLC member of a pass-through entity does not pay taxes based on money distributed to them, but on their proportionate share (known as pro-rata share) of the LLC’s profits or losses. An LLC is permitted to distribute losses differently among the members –e.g. a member with a 1% interest can take 90% of the tax losses in a particular year.
This can be spelled out in your LLC operating agreement.
Similar to a single-member LLC, a multi-member LLC that is taxed as a partnership or S corporation, does not pay taxes on net income. Instead of the entity paying taxes, the pass-through taxation is reported on each member’s tax return on the IRS K-1 form (Schedule C for single-member LLCs that are taxes as a sole proprietorship). The amount on the K-1 can be the same or different from the amount distributed.
LLC distributions can be made to investors even if you don’t have profits (or, conversely, you can distribute less than the full amount of profits). These payments can be characterized as interest on a loan, or as guaranteed payments.
Once you get multiple classes of members, with different allocations of profits and distributions, you really ought to get the advice of an attorney or accountant. These are not the type of operating agreements to draft on a napkin after reading something on the internet.