“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!