Suppose a two-member LLC taxed as a partnership has a set of projects that are joint initiatives of the members, as well as projects that are solo initiatives of one or the other member. For example, the same corporate entity handles a shared venture and solo consulting work by each member.

What is the right way to calculate the allocations for profit, loss, and capital?

Consider only the solo projects for now. Easy case: both members have net positive income from their projects, or both have net negative income. Then the percentage split of profit or loss is clear.

Challenging case: member A's project has net positive income: gross revenue is $50k, expenses are $5k. But member B's project has net negative income: gross revenue $45k, expenses $50k.

The business as a whole has net positive income: $40k. But one partner's project is in the red, while the other is in the black. What is the standard way to calculate the profit and loss percentage splits?

Should A receive a 50/95 share of profit and a 5/55 share of loss? This strikes me as incorrect, because net negative income would be recorded as a negative profit for form 1065. If so, then how can profit and loss be allocated fairly in this situation?

  • 4
    There is no "right way". It's whatever you agree on. If you are 50/50 partners, then the norm would be to assign salaries appropriately and then split profits or losses 50/50 regardless of what happens, just like when you're married. There's an infinite number of ways to deviate from the "norm"; just make sure all parties agree to it, and I'd recommend signing a contract in case someone decides to disagree later. – TTT Aug 13 '17 at 23:45
  • @TTT I'd argue that the only "right" way is what's spelled out in the partnership agreement and anything else is wrong. – iheanyi Aug 15 '17 at 6:29

You should have a partnership agreement of some sort. The reason partnership agreements exist is so nobody can change the game because of the outcome.

I'd say the most typical partnership agreement is that everyone gets an equal cut, meaning that everyone also makes an equal contribution. If you have start up expenses of $10,000, you'd each contribute $5,000. Separately, you can determine ownership share by contribution amounts, maybe one of you contributed $2,000 and the other $8,000; this would be an 80/20 split.

The performance of the operation doesn't have anything to do with determining how to divide the pie, your partnership agreement determines that. How much have you each contributed and what agreement did you make before you decided to be partners?

If you have a poor performing business segment, then the partnership should get together and consider adjusting or stopping that line of business. But you don't change how the pie is divided because of it; unless your partnership agreement says you do.

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