How Net Income Distribution Works
Business Models & Organizational Structure
By Tim Plaehn
Going From Multi Member LLC to Single Member LLC
How to Understand an LLC
Advice on Reducing My Payroll Tax Liability
Differences in a Partnership and Corporation for Tax Treatment
Can Partnerships Have Shareholder Loans?
The majority of small businesses that have more than one owner use a business structure that avoids income taxes for the business and passes through results to the individual owners to claim profits and losses on their individual tax returns. Income distribution to the owners of a small business divides into two distinct categories -- income tax reporting and actual cash payments.
Small-Business Organization Structures
Pass-through business entity types include S corporations, partnerships and limited liability companies. To function as a pass through, an LLC will file taxes as a partnership. These business types file a business tax return but are not liable for any business income taxes. The tax return allocates profits, losses and deductions to the owners of the company. Each owner receives an Internal Revenue Service individual schedule K-1 listing the owner's proportionate share of the income and deductions. The owners then use the K-1 numbers to report the results on their personal tax returns.
Salaries Or Draws For Owners
For the small-business owners who work in the business, it may be nice or necessary for an owner to receive a regular paycheck. For a partnership, any payments to the owners will be a draw against future profit distributions. The draw will not be classified as a salary. With an S corporation, the tax rules require that owners acting as managers be paid a salary and that payroll taxes for Social Security and Medicare be withheld and paid for any owner-employees. The salaries paid to S corporation shareholders reduce the net profits available to be divided among the company ownership.
Internal Directives Control Cash Flow
While the tax rules control how profits are allocated for reporting purposes, a small business is not required to pay out all of the net income to the owners. The partnership or operating agreement of the company will dictate who controls the distribution of cash profits and the company guidelines for the distributions. With an S corporation, there will also be a board of directors that votes on the amount of profits that will be paid as dividends to share owners. A company may elect to keep some of the net profits in the business to fund future projects to generate even higher levels of profit.
Proportional Ownership -- Usually -- For Profits
With both partnerships and S corporations, the amount of net profits paid to each owner will be proportional to each ownership percentage. A partner who owns 40 percent of the business and an S corporation owner with 40 percent of the shares will each receive that percentage of any profit distributions. An exception can be made within the LLC business structure. An LLC operating agreement may give an individual owner a percentage of the business profits that is different from her ownership stake.
Internal Revenue Service: Paying Yourself
Tax Foundation: Individual Tax Rates Impact Business Activity Due to High Number of Pass-Throughs
Intuit: Salary or Draw? How to Pay Yourself as Business Owner Read more: http://blog.intuit.com/money/salary-or-draw-how-to-pay-yourself-as-business-owner/#ixzz2lnnZk03r
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.
The Distribution of Revenue for an S Corporation
How Are K-1 Earnings Distributed?
How Can the Owner of a Corporation Draw Money From the Company?
Can You Take Net Income & Reinvest in a Company?
How to Take Disbursements From a Corporation
Rules of an LLC
How Do Taxes Work for an LLC?
How to Figure Out Subchapter S Shareholder Earnings
Tax Treatment of S Corp Dividends
1 The Distribution of Revenue for an S Corporation
2 How Are K-1 Earnings Distributed?
3 How Can the Owner of a Corporation Draw Money From the Company?
4 Can You Take Net Income & Reinvest in a Company?