Can an LLC reimburse Members for taxes paid on LLC profits?

The LLC can certainly make a cash distribution to the members to cover the tax liabilities they incurred. Profitable partnerships and S corporations often distribute enough cash to their owners to cover their individual income tax liabilities. The distribution would be just that, and would have no tax effect to either the LLC or the members, apart from reducing the members' basis in the LLC.

Katie in San Diego

On Jul 9, 7:28 pm, Katie wrote:>

When Katie says, "no tax effect to ... the LLC," she means the LLC does not report a deductible expense for this distribution. There is no tax deduction for anyone for the payment of federal income taxes.

Right, Bill, thanks for the clarification.

Katie

Thanks Bill and Katie -

Is the distribution taxable to the members? Is it reported on the K-1's?

The LLC's income passes through to the members and is taxed to them whether or not it is distributed. That's what has created the tax liabilities you would like to have the LLC reimburse.

Distributions of income that the members have already paid tax on are not taxable income to the members. The distribution would be reported on Schedule K and each member's K-1 under Part II, item L, "withdrawals and distributions." They reduce the member's capital account.

Katie in San Diego

I would think the distribution should be in proportion to the LLC members' proportion of the LLC profits shown on their K1, since some members may be in different marginal tax brackets. Not simply "reimbursing" each member for its tax liability.

On Jul 10, 10:54 am, "Gil Faver" proportion of the LLC profits shown on their K1, since some members may be

That would depend upon the agreement among the LLC members.

"Gil Faver" some members may be in different marginal tax brackets. Not

Normally that's the case. But it doesn't necessarily need to be. The IRS says that distributions must reflect economic reality - not just, for example, give most of the profit to the low income partner and the deductions to the high income partner.

I don't know if this particular issue has been litigated, but it seems to me that it could well be a permissible way to do things. Of course, the disbursements would have to be properly reflected o the partners' K-1'.

Stu

The IRC makes that requirement for dividing up profits and losses by partnerships. There is no tax rule I'm aware of that says how distributions have to be handled.

Of course. But I don't think you can really divorce the two. If an unequal distribution is made in a way that is reflected in the partners' capital accounts, their ultimate interests remain the same though their relative investments will be thought to have changed. There should be no tax implication for that at all (except for the ultimate division of profits).

I suspect it's more likely that the distributions would not affect the capital accounts, but would be unequal because that's what each needs. In that case it would affect the partners' taxable distributions - in other words their relative profits.

Stu

No, Stu, you can't change the distributive shares of income by making distributions. As long as the members agree and the distributions don't violate the operating agreement, each member can receive a different amount of distribution, and the distribution affects that member's capital account. So the members end up with different capital amounts and different tax basis in the LLC. That's fine as long as it doesn't violate the operating agreement. Of course it will potentially affect each member's ability to deduct his or her distributive share of future losses, and any gain or loss on sale or other disposition of a member's interest in the LLC.

Katie in San Diego

Thanks. I was thinking that if I'm a 50% owner and receive a greater distribution than my partner, to the extent I got more that could be treated as a redemption, reducing my share from 50% to, say 49.5%.

Exactly.

The issue was whether or not partners or members in an LLC can receive differing distributions in the amount that their LLC income increased their income tax. My initial thought is that something like that has economic substance so it would be permitted. But if they do that, it has an effect beyond simply the disbursal of money, because the difference has to be dealt with somewhere - I'd guess the capital account, though you might have better ideas for that.

Stu

I don't think it matters why the distributions are made -- to cover the taxes or just because the partner/member needs the money for whatever purpose. If this were an S corporation the distributions would have to be made in proportion to the stockholders' percentages; otherwise the S election could be blown. But in a partnership, as long as the partnership agreement or LLC OA allows it, I don't think there is any rule about disproportionate distributions. Sec 704 (substantial economic effect) applies to the determination of distributive shares, not cash distributions.

A distribution to a partner from a partnership is not taxable income to the partner unless it is in excess of the partner's basis. No gain or loss is recognized by the partnership on the distribution of property, including cash, to a partner. IRC Sec 731.

Katie in San Diego

Thanks Katie. Great information.

Stu

yes, great info. But I said "should". I mean, what the heck do I care about what tax bracket my co-owner is in? If I put in x%, I want x% out. Or, if the other co-owner is contributing management skills, so I put in x% and I get y%, I want y%, not something other than y% concocted based on various tax brackets.

but hey, that's me.

"Gil Faver"

On Jul 11, 9:02 am, "Gil Faver"

Better put it in the Operating Agreement, Gil .

Katie

yes, but if nothing about taxes is stated in the operating agreement, then any payments to help cover tax payments would have to be pro rata, based on profit distributions. In other words, if you want payments to cover tax liabilities even though some members are in different tax brackets, THAT should be spelled out in the operating agreement.

I think we've missed a chance to make this *more complicated*. For example, in a partnership that's got "fixed" percentages, but pays its partners guaranteed payments for their services - based on something other than the fixed partner percentages - there's always the possibility that the partners agree to give the partners a "kicker" to help them pay their taxes on their partnership income. If the kicker is paid as a guaranteed payment, then the complications begin...!! I could go deeper into this morass but I get confused when I try to think and type at the same time.

e.g. two partners are 50-50 in ownership of a business, but one partner's working full-time for the partnership and one's either wealthy or retired or lazy (or all three, but why identify myself so carefully) and only puts in a few hours a week. However, the wealthy, retired, lazy partner is just making sales calls, while the "full- time" partner handles all the administrative crapola in addition to being in sales, too. The partners agree that their guaranteed payments for any year will be a combination of an hourly wage for the admin partner's time spent "in the office" plus a "commission" on the sales generated by each partner, plus a "kicker" to help them pay their taxes. End result: the partners are 50-50 but their "tax kicker" won't - not by design at least - be 50-50, but since it's paid as a guaranteed payment, it's deductible 50-50 even though it may be paid out in any ratio that the formula determines.

What the formula would be for the tax kicker, well that's an entirely different story, it'll be in the next chapter of my upcoming book "Real World Solutions to Nagging Puzzles in Flow-Through Entity Taxation".

[footnote: when the "worker" partner approached the "retired" partner about this "tax kicker" payment the "retired" partner (the rich lazy one) said something like "Well, son, you just pay your taxes like everybody else does, by writing a check to the gummint." Then he was reminded that he was rich and retired and lazy, and the other guy really had to make it on what he could earn from the partnership. They agreed on a formula for a deductible payment to each of them "for taxes". One that wouldn't deplete their capital accounts unsymmetrically.]

Just kidding about "my upcoming book"...