LLC Accounting – Allocations vs. Distributions

Accountant's green and white ledger page, symbolixing LLC accounting practices

An entrepreneur who was trying to prepare a limited liability company (LLC) Operating Agreement on his own (apparently using someone else’s as a template) was puzzled by the concept of “sharing losses”. I could tell right away that he was not familiar with two fundamental concepts of LLC accounting: Allocations vs. distributions.

Before going further, I need to make two disclaimers:

  1. This post is not about taxes.
  2. The following discussion is extremely simple, addressing only the most basic considerations. One of the great things about LLCs is that the members can agree to make allocations and distributions in any way they desire to meet their business needs. As a result, LLC accounting can be far more complex than the following might suggest.

Each member has a capital account that represents his equity in the LLC. At the time he becomes a member, he makes a capital contribution (cash or property) to the LLC. The value of that contribution becomes the value of his capital account.

Over time, as the LLC operates, profits and losses are allocated to members. Profit allocations increase members’ capital accounts; loss allocations decrease capital accounts.

If the LLC has available cash (or other property), it may make a distribution to members. The value of the distribution reduces each member’s capital account.

Example: Assume that A is one of two members of an LLC. Assume, further, that the Operating Agreement specifies that the members will make equal capital contributions and will receive equal allocations and distributions. The following describes LLC accounting that could apply.

  • If A’s initial capital contribution is $25,000, then his capital account will have a value of $25,000.
  • If the LLC has a loss of $100,000 during the first year, then one-half of that amount ($50,000) will be allocated to each member at the end of that year, and A’s capital account will have a value of -$25,000.
  • If the LLC has a profit of $200,000 during the second year, then one-half of that amount ($100,000) will be allocated to each member at the end of that year, and A’s capital account will have a value of $75,000.
  • If the LLC has $50,000 available cash to distribute, then one-half of that distribution ($25,000) will go to A, and his capital account will have a value of $50,000.

Related post: Can an LLC have Members with a Non-ownership Economic Interest?

Photo credit: Paige Foster via stock.xchng

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

6 comments

  1. Harry Gilbow says:

    Very interesting. Isn?t it one of the flexible benefits of an LLC that you can allocate profit/losses in a different proportion than the capital/property contributed?

    Tx. H.G.

  2. Dana says:

    @Harry Gilbow
    Absolutely – please see Can an LLC have Members with a Non-ownership Economic Interest?. (I just put a cross-reference to that post in this one.)

  3. Pete says:

    I am about to start a two-member LLC but I am still a little confused. What are some of the issues I want to consider before having disproportionate allocation/distribution. Can the distribution vary from year to year or does it raise a brown in the eyes of the IRS?

    Thank you

    • Dana says:

      It appears that your question can be answered more appropriately by an accountant / tax advisor than by a lawyer.

  4. Ric Ruller says:

    Dana,

    In an LLC where the Membership Agreement calls for year end distributions of profits to members, on a Pro Rata ownership basis, do the distributions have to occur at the same time once the amount is determined and the decision to make them has been made?

    For example, if the agreement says that the Managers determine the “amount and Timing” of distributions, does timing imply that once one member receives their distribution, all other members have to receive their pro rata amount (unless, of course, they waive that right in writing, electing to defer it to a later date), at the same time?

    • Dana says:

      Keeping in mind that (a) we have not established an attorney-client relationship (thus the following does not constitute legal advice) and (b) I am familiar only with California law (which is the basis for the following comments):

      It strikes me that the answer to your question has less to do with contract interpretation and more to do with the Manager’s fiduciary obligation to the Members. In light of that obligation, I find it difficult to see how the Manager can justify favoring one Member (especially – I’m just guessing – if that one Member is himself!) to the detriment of the other Members.