Distributions to LLC Members Vs. Dividends
A Limited Liability Company (LLC) does not have shareholders as would a corporation. Instead of paying dividends, an LLC distributes profits among its members, as owners are called. The difference between dividends and distributions comes in how each are taxed, and the state and federal regulations that cover these payments. Which is most advantageous depends on a company's specific situation.
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Distributing Profits
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An LLC with more than one member is by default treated as a partnership, and any profits the company realizes is reported on each member's individual tax return. PowerHomeBiz.com notes the proportion of profits distributed to each member is determined by agreement between the members. For instance, if all members put in the same amount of funds to start the LLC, but one member does most of the work in running the company, the members can decide to give that person a disproportionate distribution of the profits to compensate for his efforts.
Dividend Payments
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Corporations have no flexibility in how its profits are split up among its shareholders. The dividends, by law, are distributed by the ratio of stock ownership. These dividends are not deductible for the company. The Company's entire net income is subject to tax, and dividends are taxed again on shareholders' returns.
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Self-Employment Tax
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In an LLC, profits escape the double taxation that occurs on corporate dividends. Yet all of a company's net income is subject to a self-employment tax to cover Social Security and Medicare. Each member must pay the tax on her share of profits as reported on her tax return.
Dividends and Salaries
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Dividends are not subject to self-employment tax, but a shareholder who serves an active, managing role in a corporation can also draw a "reasonable" salary based on industry standards. A combination of dividends and salary can result in a significant tax savings for a company manager, even though the salary is subject to standard state and federal withholding. But if the IRS determines the salary is unreasonably low to simply avoid taxes, the agency may reclassify dividends as salary.
Weigh Options Carefully
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Tax and legal advantages can be found in either an LLC or a corporation. In addition, federal law allows a company to be taxed as a corporation even if it's still an LLC under state statutes. Accountants and government agencies warn that the particulars of each company's situation and the nuances of tax law require expert advice when trying to determine the best business structure for a company.
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