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How Maryland and Delaware LLCs Share Profits Among Members
Both the Maryland and Delaware LLC Acts (the "LLC Acts") provide LLCs with virtually unlimited flexibility in allocating their profits and losses among their members. This flexibility does not benefit LLCs that elect to be taxable under Internal Revenue Code Subchapter S, since Subchapter S entities are required by the Internal Revenue Code to allocate their profits and losses among their members on a strict per-share basis.
However, the allocation provisions of the LLC Acts are helpful to the relatively few LLCs that are taxable under Subchapter C, since it allows these LLCs, through the use of preferred stock terms or the like, to allocate their profits among their shareholders in a manner that is disproportionate to contributions. (An entity taxable under Subchapter C cannot allocate its losses among its shareholders, since these losses are treated as exclusively the property of the entity itself.)
However, the allocation provisions of the LLC Acts are helpful to the relatively few LLCs that are taxable under Subchapter C, since it allows these LLCs, through the use of preferred stock terms or the like, to allocate their profits among their shareholders in a manner that is disproportionate to contributions. (An entity taxable under Subchapter C cannot allocate its losses among its shareholders, since these losses are treated as exclusively the property of the entity itself.)
Furthermore, the allocation provisions of the LLC Acts allow LLCs taxable as partnerships under Internal Revenue Code Subchapter K to allocate their profits and losses with almost unlimited flexibility, subject only to the general policy of Subchapter K against allocations that are tax- motivated and make no sense economically. The great majority of multi-member LLCs are taxable under Subchapter K. In practice, the most common allocation methods employed by LLCs taxable under Subchapter K are the following:
1. Allocations proportionate to contributions. By far the most frequently used method is to allocate profits and losses in proportion to the value of members’ contributions. Thus, if I contribute one third of the LLC’s capital, I am entitled to one third of its profits. This is the "default" method of allocation under the LLC Acts, and for most LLC members, it is the method that is fairest and that makes the greatest economic sense.
2. Per capita allocations. The members of some LLCs, however, may decide that although some of them are contributing more actual cash than others, the overall contributions (including contributions of services) are likely to be of equal value in the case of each member. These LLCs allocate profits equally among the members regardless of their contributions.
3. "Special" (disproportionate) allocations. Finally, a few LLCs make what tax professionals refer to as "special" allocations among the members. These are allocations that are disproportionate to capital contributions.
Special allocations can be powerful tools for LLCs in attracting and retaining talent and capital. They can take an infinite variety of forms. For example, an Operating or LLC Agreement may provide as follows:
1. Although all members shall make the same cash contribution, all profits shall be allocated to Jones until these allocations equal Jones’s contribution.
2. The LLC shall allocate profits equally among the members but shall distribute all of its profits to Jones until he has received back the entire amount of his contribution.
3. Jones shall contribute to the LLC the capital necessary to purchase a particular truck, and all depreciation allowances in respect of that truck shall be "specially" allocable to Jones. In short, the LLC Acts give LLC members and their lawyers and accountants tremendous scope for creativity in tailoring the allocation provisions of the LLC to meet member needs and interests.
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Maryland Small Business Lawyers
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2275 Research Blvd
Suite 500
Rockville, MD 20850
Maryland Small Business Lawyers
Rockville | Bethesda | Gaithersburg | Germantown | Potomac
Washington, DC