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Show me the money

by Bruce
(Port Charlotte, Florida, US)

How do I get paid as a managing member of an LLC?

Answer

You write a check to yourself from the LLC's bank account.

Payments received by members from the LLC can be any of the following:

1. Guaranteed payments
2. Share of profits
3. Repayment of interest/principal of loans made by member to LLC.
4. Return of a capital contribution to a member

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Show me the money

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Jun 08, 2011
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starstarstarstarstar 		Return of Capital
by: Anonymous

Are there tax consequences for the return of initial investment capital? For instance, if you fund an LLC to buy an investment property with cash. After a short time period the LLC gets a loan on this property. When the loan proceeds are given to the LLC, can these proceeds be given back to the original contributor of capital with no tax consequences?

Response

There might be some extra complications with recourse vs. nonrecourse debt you would want to consult with an attorney about if you want to deduct passive losses.

However, in terms of taking a draw from the LLC, that should not create tax liability. Neither is borrowing money an event that triggers taxable income. A cash contribution to an LLC is not a taxable event.

While this sounds like a "free lunch" initially, the IRS gets its money back over time

As the LLC repays the loan, it will deduct the interest portion of its payments as a business expense, but not the principal.

Therefore, the LLC could potentially show a taxable "profit" even though it is cash flowing negative.

Example, suppose the LLC owns a commercial building that receives $120,000 in rent and pays $144,000 in mortgage payments for the year. Of those $144,000 in mortgage payments, $100,000 was interest and $44,000 was principal (assume no other operating expenses for simplicity sake).

Although the LLC had negative cashflow of $24,000, it showed a profit of $120,000 - $100,000 = $20,000.

This is referred to in the industry as "phantom income", because you are taxed on it but cannot spend it.

This makes sense, as it is the symmetrical opposite to the LLC's position when it took out the loan and had positive cash flow without showing a profit.

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