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Have a question. I am forming an LLC for my business. The question i have is if the LLC can maintain operating capital or do i have to distribute all profits to the principles? Can it maintain a certain level of operating capital to handle expenses as they come up?
ChadNTexas,
The distributions from the LLC will follow the operating agreement. Generally, most LLCs do not distribute all of their profits to the principles/members. They maintain operating capital so that they can continue to operate the business and have monies for potential growth. If you have not finalize the operating agreement, be sure to make sure the distributions to the members are reasonable and don't eat-up all of your cash.
Kelly
To add on to Kelly’s comments, do not confuse the idea of distributing profits and distributing cash. An LLC is what the IRS refers to as a “pass through entity,” i.e., all profits and losses are “passed through” to its members (there are exceptions to this, but they are somewhat unusual and not very common).
This “pass through” does not mean the distribution of funds. By way of an example, if business generates $100,000 in profits for the year and $25,000 is distributed to its members; the taxable income to its members is $100,000.
Ed Baloga, CPA / MBA
Principal CFO
Baloga Associates
ebaloga@baloga-associates.com
www.twitter.com/edbaloga
Good points Ed. There is a difference between allocating the profits and losses to the members vs. distributions, i.e., cash payments t the members. The profits and losses must be "allocated" to the members because the LLC is a pass-through entity (and those profits/losses are reported on each members individual income tax returns), but the amount of cash actually paid out does not have to be the same as the allocations of income.
In addition to the postings above that indicate that taxable income and the amount actually distributed to LLC members are not one in the the same, there may be cases when one member is allowed to take out more than his / her basis. Basis is what one has invested including ones share of income and losses. If the amount of the distribution is more than the basis, then that member has to pay income on their share of income as well as on the excess distribution (usually on schedule D).
Following the discussion, if members decide not to draw profits and amounts are allocated into their capital accounts, would this be considered another investment? Loan to the company? Can members draw from their capital accounts?
Regards
GL
GL, if an LLC member doesn't withdraw all of the profit which is allocated to such member by the profit-allocation agreement, then the portion of such profit not withdrawn is generally added to the member's capital account. It's the LLC's analog to a corporation's "retained earnings".
It isn't generally added to a "loan to company" account, unless the member explicitly withdraws it and then loans it back to the company.
Members can usually make draws from their capital accounts, but this ability can be tempered or modified by the LLC's operating agreement. Just as an example, if the members feel that it's important for the company to maintain a certain level of positive equity the OA might restrict drawdowns to a max of some X% of a member's capital over a designated time interval.
If the members' collective capital is an important income-generating component for any given business, then those members should take note of how the members' relative investments can change over time, if some members are withdrawing the capital at a greater rate than other members. Four members might start out, for example, with each having invested 25% of the firm's total capital. But that can become skewed over time if the members are not withdrawing their allocable profits at the same rate, leaving some member(s) with much more of their personal wealth invested in the company than others.
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