By Jennifer Reuting, author of Limited Liability Companies for Dummies™
Question:
Does the IRS tax you on the actual cash distributions received or your member allocations? I am forming an LLC, and I want to retain 51% voting rights while my partner will have 49%. I want to distribute the profits evenly to him, myself and a third-party developer at 33% with special allocations. We are building an online software application and have virtually no money to pay the developer and don't want to dole out ownership shares.
Answer:
MyLLC.com often receives questions regarding cash distributions when you operate an LLC. While we highly recommend that you speak to your personal tax adviser regarding any distribution questions. However, the following information provides a general overview of cash distributions and the basic policy instituted by the IRS.
If your LLC is subject to partnership taxation then the IRS will tax you on the allocations, not the actual cash distributions. However, varying the allocations is not as easy as it sounds and best to be avoided if possible. Ownership aside, a solid strategy is to issue your companies programmer a Profit Sharing Agreement which gives a specific definition of the profits being shared (i.e. if it is "net" profits, then what will be deducted) and pay that individual as an independent contractor. This will be tax-deductible to your company and you can then share the remaining profits with any partners according to ownership percentage.
The critical aspect is to make sure your LLC is above reproach and holds a Certificate of Good Standing. If you are considering paying cash distributions to partners in your company, you can be assured the IRS will start paying closer attention to your business. When you partner with MyLLC.com when forming your LLC, our highly experienced experts will assist you in keeping your LLC in good standing. Contact us today for further information.
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