Distributions: who decides when the money comes out

The company made money. The allocation machinery already decided whose profit it is on paper, and the tax system will act on that paper regardless. What the distribution clauses decide is the part everyone actually cares about: when the paper becomes cash, who has the power to make that happen, and in what order the cash flows when it does. The gap between profit allocated and cash distributed is where this section’s silence costs live, because the state-law spine’s distributions page already established the uncomfortable physics: members are taxed on allocated profits whether or not they ever see them.

What the clauses do

Three jobs. The trigger: whether distributions happen at someone’s discretion, usually the manager’s, or mandatorily on a schedule or formula. The order: pro rata to ownership in the simple company, or a waterfall in deals with a money partner, capital back first, then a preferred return, then the split, the architecture the syndication pattern runs on. And the floor: the tax distribution clause, which promises each member at least enough cash each year to cover the tax on the profits allocated to them, computed at an assumed rate the agreement states.

That floor is the clause everyone forgets, and it is the most important paragraph in this section for any company that retains earnings. Without it, a profitable company that keeps its cash sends every member a real tax bill and no money to pay it with.

What silence costs

The defaults answer the trigger question with near-total discretion: in most states, no member can compel an interim distribution, and cash comes out before dissolution only when whoever holds the management power decides it does. Silence then answers the order question, and in a stripe of states it answers it equally per head, the same per-capita ambush this manual keeps finding: absent drafting, the 90/10 company may owe its distributions 50/50. And silence provides no tax floor at all, which combines with the discretion default into the full phantom-income package: taxed on profits you cannot reach, with no right to a dime.

For the solo owner none of this bites; you are the discretion. The costs are entirely a multi-member phenomenon, and they compound with every point of ownership you do not hold.

The real options

Discretionary distributions with a mandatory tax floor is the pairing that fits most companies, and the two halves belong together. Discretion, lodged with the manager, keeps the company able to retain cash for real needs without a member vote over every dollar, and it happens to be load-bearing for creditor purposes too: the charging order’s whole value assumes distributions a creditor cannot force, a design this manual’s creditor-hardening section will draft in full. The tax floor underneath removes discretion’s sting: whatever the manager retains, every member gets the assumed-rate tax amount on their allocation, timed to estimated-tax deadlines rather than April, because the IRS bills quarterly. Set the assumed rate uniform for all members at a stated number, deliberately generous, and resist per-member actual-rate computations, which turn every distribution into an audit of each other’s tax returns.

Mandatory distribution formulas, all net cash flow quarterly, or a stated percentage of profits, fit investor deals where the members bargained for income and the manager’s discretion was never part of the deal. The drafting must bow to two masters, though: state law forbids distributions that render the company insolvent, and loan covenants routinely forbid more, so every mandatory clause needs its yield-to-law-and-lenders sentence or it is a promise the company may be forbidden to keep.

Waterfalls belong to money-partner deals and to lawyers, and the only drafting note this manual adds is the one the syndication page implies: the waterfall and the tax floor must be reconciled on purpose, because a preferred-return structure can allocate profits to a partner the waterfall pays last.

The trap

The trap is the starvation machine, and it is built from standard parts. Full discretion over distributions, no tax floor, and a majority owner who also controls compensation. The majority stops distributing, pays itself through salary and management fees instead, and the minority member receives exactly two things each year: nothing, and a K-1 taxing them on their share of profits the majority is consuming as wages. Every part of that machine is a clause someone signed, usually from a template, usually without reading it, and it is among the most litigated patterns in closely held companies, dressed in claims of oppression and freeze-out that cost more than the company was worth.

The fix costs two clauses at formation, when everyone is friends: the mandatory tax floor, which caps the starvation at zero rather than below it, and a compensation provision requiring member approval, or at least disclosure, for payments to members and their relatives outside the distribution waterfall. A minority member who cannot be starved and cannot be diluted through the payroll has lost the two levers that make freeze-outs work, and the majority who resists those two clauses at formation has told you something worth knowing before you sign.

The state-by-state defaults behind this section will get their specifics on this site’s state pages.