For LLC Owners: The Difference Between Allocations and Distributions

“Why do I have to pay taxes on money that did not get distributed?!”

This is a question that many LLC owners (know as “members”) ask me. The confusion (and obviously frustration) of paying out taxes on money that you never received is real, but much of it stems from the lack of understanding that in the realm of LLCs there are “allocations”, which handles how profits and losses are allocated among the members and there are “distributions” the actual distributing of cash or property from the LLC. Many business owners like to conflate the two concepts together, which is not the case, and thus creates their confusion.

I provide an informational sheet for readers to take a look and get the basic understanding of the difference between allocations and distributions (see below).  The tax matter aside, the divvying up of allocations and distributions that is a discussion that business owners should have prior to organizing a LLC and then having an operating agreement drafted for them because of not just the tax issue, but due to the flexibility of LLCs of having allocations and distributions not match ownership interest, and the timing of distributions.

Again, communication is fundamental for business owners and a lot of discussion and pre-planning goes a long way to avoid the deterioration of the relationship because these were not hashed out prior to the formation of the business. As discussed in previous posts, LLC owners starting out would want these agreed upon terms on allocations and distributions reduced to writing, and is usually found in the Operating Agreement.

If you would like to see the information sheet, click here and then look for the downloadable pdf entitled, “For LLC Owners: Difference between Allocation and Distribution”.

Mahalo for stopping by and reading my blawg!

-RKH

Episode I: You May Dispense with the Pleasantries, Not the Formalities . . . Don’t Forget to Sign!

*Disclaimer:  This post discusses general legal issues, but does not constitute legal advice in any respect.  No reader should act or refrain from acting based on information contained herein without seeking the advice of counsel in the relevant jurisdiction.  Ryan K. Hew, Attorney At Law, LLLC expressly disclaims all liability in respect to any actions taken or not taken based on the contents of this post.

So I am going start this post with one of my favorite movie villain’s quote: “You may dispense with the pleasantries, Commander. I am here to put you back on schedule.”

Except instead of building a space station, I am here to help you build your business by recognizing that while you can skip the pleasantries in business, you should NOT ignore the legal formalities.  I realize some of you business owners find your attorney, CPA, compliance officer, and the like as pains in the butt by sometimes being overly cautious, but please understand that these advisors suggest caution because they see how bad it can get when you don’t follow their advice.  So this post and several that will follow shall focus on legal formalities that I have seen business owners fail to follow.  By failing to observing these simple formalities these owners spent great time and expense trying to fix them, and some of them are unfixable.

Sign Your Papers

So today’s post what am I talking about?  Well, for this post I am talking about something so basic.  Namely, don’t forget to sign your agreements.   Before you laugh, consider how many times some asks you to do something so simple, you procrastinate on it to the last minute because you think it is so simple take care of later.  Consider in that in today’s technological world it is easy to text, email, etc . . . so some people feel, why bother signing a piece of paper?  Let me share a story that I see constantly among current and past clients: the unsigned Operating Agreement/Bylaws/Partnership Agreement.

I have had clients who have gotten into disputes with their business partners.  It might be suspicions, poor communications, changed expectations, but in general the relationship is deteriorating and these former allies, now want the other side out of the business or they want their share bought out.

So by the time the distressed business partner comes to me I will ask, “Where is your Operating Agreement?” I will be using a LLC as an example, but this applies to corporations, partnerships, and in general many relationships.  They usually have an Operating Agreement and aside from the host of other problems, such as lack of adequate protection, incorrect names or usage of terms, etc . . . I get to the end of the document and find it is unsigned.

What’s an Operating Agreement?

Before I continue, let me explain something about an Operating Agreement. This document acts as internal document that sets up the rules and procedures among the members (the owners) of a LLC, and may dictate how one becomes a member, sells their ownership interest, and handles voting, profit-sharing, etc . . . Suffice it to say, you should have an Operating Agreement if you have a LLC, regardless if it is member-managed or manager-managed.  It gives you the rules of interaction.  I have even seen problems where clients did not even bother having an Operating Agreement drafted, which is just worst than not even having one unsigned.

The Problem with Unexecuted Paperwork

Anyway, when your Operating Agreement remains unexecuted (unsigned) or any paperwork for that matter, it would indicate to an attorney that the parties had no intent to be bound by the document.  After all, “why didn’t you sign it?” is the question that comes to mind.

Unsigned documents are just paper with pretty words.  In the law we expect you to take an active act to be bound by those pretty words, and that active act is signing the documents.  The signature serves as evidence.  Consider for a moment that is why even in our electronic world, we make you go through hoops to “click”, “check the box”, or “electronically sign”, basically showing that you “read” the terms and by your action you agree to be bound to them.

So getting back to this situation where the parties have a dispute, but have unsigned paperwork the question remains what were the terms of the contract.  It is true in a lawsuit you can prove there was intent to be bound under the agreement by showing that the parties took active steps to be bound by the unsigned document.

However, don’t you think it is easier just to produce a signed document as evidence rather than cobbling together various pieces of evidence to demonstrate that the parties meant to sign it?

With an unsigned Operating Agreement, you may find yourself stuck with the default rules at law to guide your dispute with regard to fellow members in a LLC.  The defaults rule set at law are very broad and offer very little help in resolving a dispute among members.  So if you are going to take time to prepare a proper Operating Agreement that covers all your bases in a LLC relationship, don’t forget to get it signed by your business partners and sign it yourself, that way at least you know what to look at for guidance when problems start.

Stop back and I will talk about some of the problems you may face forgetting to do your Annual Filings or missing a renewal date!  Mahalo for reading!