Llc Agreement with Profits Interest

While the concept of granting a share of profits in your LLC may seem simple, there are additional tax requirements that have not been discussed above that must be met to ensure that beneficiaries are entitled to receive interest on profits (e.g. B, the dreaded “capital account book”) (see IRS Rev. Proc. 93-27 and 2001-43). LLCs do not issue “shares” but “member interests” or “shares”. Most LLCs that have multiple members are taxed as partnerships for federal tax purposes and do not choose to be taxed as a corporation. For LLCs taxed as partnerships, the next equivalent of an option to purchase shares in a corporation is called “profit sharing.” When you give a person a share of the profits in an LLC, that person receives a share of both the LLC`s future profits and the appreciation of the LLC`s assets. Since the profit-sharing beneficiary receives only interest on the LLC`s future profits and the appreciation of the LLC`s assets, the grant of interest on profits, if done correctly, should not result in taxable income receivable at the time of grant. For example, if you get a share of the profits in an LLC in the amount of 5% of the outstanding equity of the LLC, you are entitled to 5% of the LLC`s profits after the date you received the interest on the profits.

Also, let`s assume that the LLC was created on the day you received the interest on profits, valued at $1 million. A year later, a buyer bought the LLC`s assets for $2 million. Since the LLC`s assets have increased in value by $1 million, your beneficial interest at the time of sale would be equivalent to 5% of this value increase, which is equivalent to $50,000. You would not be entitled to any $1 million value allocated to other members prior to your interest in profits. To create and spend profit interest, an LLC typically needs to modify its operating agreement to create a new category of membership interests or entities that take the form of profit interests. Current members hold interests in the LLC (which we would normally refer to as “Class A Units”), and beneficiaries of the Recipient Shares would likely receive “Class B Units,” which must be clearly identified and determined as a profit-sharing in the LLC`s operating agreement. The class of beneficial shares may be voting or non-voting shares. We`d be happy to discuss these complexities with you if you think profit interests might be a good option for you and your LLC. Please contact me at haveman@carneylaw.com if you have any questions. Like stock options, the granting of a profit share should not result in a taxable event for the beneficiary at the time of grant. Unlike stock options, the beneficiary of a share of the profits does not have to pay an exercise price to receive the equity interest represented by the interest on the profits. Upon receipt of interest on earnings, the beneficiary is a member of the CLL (an option holder holds only one stock option and is not a shareholder until he exercises his option and pays the strike price).

Like stock options, the granting of a profit share may be subject to an acquisition schedule. The acquisition may be based on time or performance, so that the recipient is invested in equity if it continues to provide services to the LLC, or meets certain performance targets set by the LLC`s management. A beneficiary of a share of the profits can no longer be considered an employee of the LLC for federal income tax purposes. Instead, once the beneficiary receives the profit interest, they must be treated as a “partner”. This means that instead of having income and employment taxes withheld from their paychecks and getting a Form W-2, they must instead make quarterly tax deposits themselves as self-employed, pay taxes for the self-employed, and obtain a K-1 form from the LLC. A stock option beneficiary, on the other hand, continues to retain employee status and receives a W-2 that declares its salary or holdback information. If you want to give employees an incentive for fairness, but you do not want them to stop being employees for federal income tax purposes, you can spend the equity of a separate corporation created for that purpose. It`s expensive and more administratively burdensome, but employees generally prefer taxes to be withheld from their paychecks in their name.

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