Splitting ownership in an LLC can seem daunting, but it's actually fairly straightforward.
By following state laws and including the proper provisions in your LLC operating agreement, LLC owners can divide profits and losses fairly while still maintaining the limited liability protection of an LLC. This article will outline the steps you need to take to split ownership in an LLC. Keep reading for more information.
Step 1: Check State Laws
Ownership in a limited liability company can be split any number of ways, as long as it is specified in the LLC's operating agreement.
However, sometimes state rules will dictate how profits and losses are divided among LLC members. It's essential to check your state law before splitting ownership to ensure you're following the correct procedures.
Step 2: Draft an LLC Operating Agreement
In order to split ownership in an LLC, you will need to draft an LLC operating agreement.
This document will outline how profits and losses are divided among LLC members and other controlling provisions such as voting rights and management structure. It is vital to have a solid operating agreement in place so that everyone involved knows their rights and responsibilities.
Step 3: Specify How Profits and Losses Are Divided
Member's LLC ownership interest and percentage ownership are the two most important factors in the division of LLC profits and losses.
Members will split profits and losses equally in most cases, but this is not always required. If one member contributes more money or assets to the LLC than another, they may be granted a more significant ownership interest or percentage ownership.
Another critical factor to consider when splitting a company's profits and losses is how liabilities are divided.
If one member is more liable for the LLC's debts than another, they may be required to contribute more money or assets to the LLC.
Member's capital contributions in an LLC ownership percentage are typically what determines percentage interest. Members' ownership interests and percentages are usually set out in the company's operating agreement. A member's percentage interest may also be increased or decreased by the contribution of additional capital to or withdrawal of capital from the LLC, respectively.
Operating agreements can be amended as needed, so if members later decide to change how profits and losses are divided, they can do so with a simple amendment to the agreement.
Profit distribution doesn't necessarily have to follow ownership percentages. Members can agree to a different distribution scheme in the operating agreement. This could result in one member receiving a larger share of profits even if they own a smaller percentage of the company.
Ownership in a Single-Member LLC
A single-member LLC has only one owner who is the sole owner of the business entity.
As such, the LLC is disregarded for tax purposes, and the member reports all business profits and losses on their individual income tax return (like a sole proprietorship). This can be advantageous because the owner of a single-member LLC enjoys limited personal liability for the debts and obligations of the company.
Profit distributions within a single-member LLC are not complicated because there is no profit sharing with other members. The owner simply takes whatever profits they earn from the business and pays themselves accordingly.
The owner is not required to pay self-employment taxes on income generated from the LLC, but they are responsible for paying income taxes on profits earned. The company itself does not bear any federal or state taxes.
Ownership in a Multi-Member LLC
Limited liability companies with multiple owners are called multi-member LLCs.
A multiple-member LLC is a business entity that provides limited liability protection to its owners. In other words, the personal assets of the LLC's owners are protected from any liabilities incurred by the company.
The ownership and management of a multi-member LLC are determined by the operating agreement, which is an agreement among the LLC's owners. The operating agreement also defines the member's capital account.
A special allocation clause in the operating agreement can be used to allocate profits and losses among the members that are not proportional to their ownership interests.
Special allocations can also be used to determine how distributions are made from the LLC.
If there is no special allocation clause, LLC's profits and losses are generally allocated proportionally to each member's ownership interest.
Related Article: How Many Owners Can an LLC Have?
Do LLC Members Have Equal Ownership Percentages?
There are no default rules for ownership percentages. Instead, LLC members can receive distributions based on their ownership percentage and vice versa. This usually works out okay, but there can be times when LLC members want to change their ownership percentages. This can happen if one member wants to sell or if another member wants to invest more money into the LLC.
Can LLC Members Take Unequal Distributions?
Yes. Membership interests in an LLC can be divided into any percentage, and members can take distributions in accordance with their ownership interests and based on the business structure. For example, if two people own an LLC equally, they would each receive 50% of the company's profits (or losses).
However, if one person owns 60% of the LLC and the other person owns 40%, the 60% owner would receive 60% of the profits (or losses), and the other 40% owner would receive 40%. Distributions can also be unequal when it comes to assets.
For example, if an LLC has $100,000 in cash and one member owns 60%, that member could withdraw $60,000 from the company, while the other member would only be able to withdraw $40,000.
Can a Member of an LLC Have 0 Ownership?
A member of an LLC can have 0 ownership. It could be a business partner or an outside investor of an LLC that is treated as a partnership or a corporation that owns all the stock of an LLC.
A member of an LLC with 0 ownership is called a "disinterested party." A disinterested party does not have any management or financial interest in the company and cannot vote on company decisions.
Can an LLC Own 50% Of Another LLC?
Yes, but this is usually the case with series LLCs. If the LLC is the subsidiary of a larger company, it can own up to 100% of the other LLC.
Additionally, if one member of an LLC wants to sell their ownership stake to another party, the LLC will need to be restructured. An LLC can own other businesses, but the company must follow state and federal laws regarding ownership percentages.
Does a Single-Member LLC Need a Capital Account?
No. A single-member LLC does not need a capital account. A capital account is only necessary for multi-member LLCs.
In a multi-member LLC, each owner's percentage of ownership in the company usually corresponds to their percentage of ownership in the capital account. This helps track each owner's contributions and withdrawals from the company.
Do You Pay Taxes on LLC Distributions?
Taxable income from LLC distributions is based on the tax classification of the owners receiving the distribution. From a tax perspective, owners in a disregarded entity (a single-member LLC) report their distributive share of income on their personal tax returns.
Members in a multi-member LLC report their distributive share of income on Schedule K and pass through any tax liability to their members. LLCs can also choose between a C Corp and an S Corp tax structure.
How Are Losses Split in an LLC?
Losses are split the same way as profits: according to each owner's percentage of ownership.
For example, if an LLC has two owners and one owner has a 60% ownership stake, and the other owner has a 40% ownership stake, then the first owner would be responsible for 60% of any losses, and the second owner would be responsible for 40% of any losses.
For many people in small businesses, the thought of splitting ownership in an LLC can be daunting. But by following state laws and including the proper provisions in your operating agreement, you'll find that dividing profits and losses somewhat while maintaining limited liability is not as difficult as it may seem at first glance.
If you have any questions about how to divide up LLC ownerships or if this seems like something for which professional legal advice would be helpful, don't hesitate to reach out to a law firm or a tax professional to guide you through the process.