Forums: Discussions for entrepreneurs and small business.

I own an LLC with a partner. We are growing quickly so virtually all of the profits this year have remained in our LLC's bank account. We haven't paid ourselves much of anything.

I know LLC taxes are paid on personal income taxes.

My question is, will we have to pay taxes on these profits, as personal income? We haven't techincally received the profits, but it was still profit.

The money stays in the business bank account however so that we have enough capital to grow the business.

An LLC is what is called a pass-through entity. The profit (or loss) that is generated flows through to the members regardless of whether cash is distributed to members. The only exception would be if the LLC elects to be taxed as a C Corp (this is unusual). The members will be taxed on their prorated portion of the LLC’s profits, e.g., if a member has a 10% interest in the LLC and the LLC had profits of $50,000, then $5,000 of the LLC’s profits would flow through to that member’s individual tax return.

Many LLC’s to distributed cash to its members to pay their tax liability that arises as a result of the additional income that is allocated to them, but that is up to the LLC members to decide.

Ed Baloga, CPA / MBA
Principal CFO
Baloga Associates
ebaloga@baloga-associates.com
www.twitter.com/edbaloga

Isn't it required to keep business and personal funds separate, even with an LLC? How does that reconcile with the idea that funds in a business account are considered to be income even if they have not been received by me?

As to your second question – unlike a C corporation where the company pays the tax on any profits (or an individual pays taxes on any dividends distributed by the company), the IRS considers an LLC to be by default, similar to a partnership or a sole proprietorship depending on whether there is a single member or multiple members (under certain circumstances, if the proper paperwork is filed with the IRS, an LLC can be treated similar to a corporation - not a very common situation).

As a partnership or sole proprietorship, all profits or losses are reflected on the members’ individual tax returns (in accordance with their respective percentage ownership of the LLC). Any distribution of cash to members does not have an effect on the amount of profits that are reflected on the individual’s tax return. The reason the cash distribution is not taxable is that in effect, you are already being taxed on the profits.

Any distribution of cash from a business account to a personal account will only reduce your equity in the LLC. Think of it like owning a house that is worth $200,000 and your mortgage is $150,000. Your equity is $50,000. You take a second loan of $10,000 against the value of the house. Assuming the house is still worth $200,000; your equity is now $40,000. You are not comingling your personal funds with business funds by taking a distribution.

I hope this helps. Feel free to send me an email if you would like to discuss this further.