Does initial contribution affect tax liability?

[JawFunk]

I have a question about schedule A and howit affects each member. As I understand it, one does have to show earned income from the three-member LLC - which I will be part of next week - on personal 1040 forms, which I normally fill out for my desk job. How does the tax code, state and/or federal, treat aditional income from the LLC? Do I have to show it, or can it stay in the company tax filings? Whichforms? What is the difference between paying out earnigs or keeping all the money in company accounts?
If on our Schedule A in the Operating Agreement we decide to divvy the member interest 20%, 40% 40%, how does that affect each members personal tax forms/liabilities or company tax forms/liabilities. We plan on recruiting an accountant part-time in the future, but we're still in the bootstrap stage.

Thank you in advance for your input.

- MC

[MSS]

A multi member LLC in most states by default will exist for tax purposes as what is called a flow trhough entity. The year end income amount is allocated amongst the owners of the LLC and recognized on the 1040 Schedule E of each owner for his or her proportionate share amount. In order to get to that point normally the LLC would also have to file and complete an IRS Form 1065 (partnership return) This tax return is intended to report the earnings of the business entity as well as who received what benefits. In spacific, generated from the 1065 is a form K-1. This form is sent both to the IRS with the 1065, and to each owner showing what is to be reported. That's how it works in general. Also, an LLC can usually choose to be taxed as a corporation, in which case, the tax rules applying to the general corporation comes into play.

[JawFunk]

Thanks MSS for the reply, it definately hepls. I will look up the forms you mentioned for better reference. The question I'm still uinclear about is this:
Lets say A, B and C want to form an LLC. The Operating Agreement does not specify initial contributions, but the members agree to divide the interest in the LLC so that A gets 20%, B 40% and C 40% - totaling 100%.

a) Is this legal? (i.e. does there have to be proportional initial contributions to reflect the percent interest)

b) How does a members interest in the LLC reflect their tax liability when it comes time to file. Will B and C have to deduct from their personal accounts, or their earnings from the LLC?

b part 2) What if all earnings are pooled for the first 3 years and only used toward company expenses and R&D?

Thanks much.

[MSS]

As for question a, by default, in most states, earnings are allocated based on contributions; however, it is usually the case that you can spell out different terms in your operating agreement. Not completely sure about how it works where you're located, but generally, it is permitted, but your allocations should meet what's called the "substantial economic effect" test. More than I care to discuss here, but if you put those words into a search engine, it should give you some idea of how to determine if your situation qualifies.

Question b, The members will be taxed based on their distributive shares of the LLC, but payment will come from the personal accounts (if the LLC exist as a partnership.) i.e. in theory the LLC makes a profit, the members take a distribution of those profits (not required though, and not necessarilly in the amount to be allocated,) and then they pay taxes on that portion of the their earnings (not the distribution taken, but their portion of the distributive shares, taken or not )

With an LLC as a partnership, doesn't matter how the earnings are to be used in the future, it works just as stated above. Each year, taxes are paid on the earnings, point blank.

An LLC as a corporation, to reiterate would work just as a normal corporation. The corporation makes a profit, and pays taxes on that profit. From there the funds are available for reinvestment or dividend payout. The funds could also be held in Retained Earnings (to avoid dividend payout,) but beware that there is such a thing as an Accumulated Earnings Tax which can be placed on excessive holdings of un-used funds held by corporations. It's around 39%