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I recently started an LLC with a business partner and quickly realized it was a mistake and we are in the process of having his name removed from the company. As no work was performed by this individual, he shall receive no income from the company. As such, he shouldn't be taxed on the company earnings as an individual. It was my assumption that no salary meant no taxable income, but I just read an article from Entrepreneur and now I'm not sure my information is correct. Specifically, the article states the following:

Each member's pro-rata share of profits represents taxable income--whether or not a member's share of profits is distributed to him or her.

What can I do to ensure this individual is not unfairly taxed for income he did not receive?

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Normally, when you make a person a member in an LLC, they automatically get a share of the profits of the LLC equal to their percentage ownership. Therefore, if you did nothing, he would be "entitled" to and hence taxed on this amount, even if you gave him nothing. The LLC files a form 1065 with partnership schedule k-1s which will reflect this amount.

In order to ensure that he is not paid for future amounts, you need to remove him as a member of the LLC, which requires looking at your operating agreement or if you have none, default state law. However, any amounts that have already hypothetically been earned by him as a member of the LLC can't be unpaid for tax purposes if you have already filed documents showing his percentage interest, the profits of the LLC, and filed official documents.

You need help with corporate law removing him as a member, and tax law making sure the profits are filed correctly on the 1065 and K-1s.

Note: This is not legal advice and does not create an attorney-client relationship.

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Basically any taxable income the LLC earned that he no longer has rights to is income that's redistributed among the other current members. So each current member reports the % boost they receive on their own tax returns as a result of his leaving and the leaving member doesn't pay that amount. This is only a guess, confirm it with a tax lawyer.

Disclaimer: This is not legal advice, should not be construed as such, nor does it involve an attorney-client relationship.

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As long as I claim the taxable income and pay tax on it, I don't see why it would be a problem. I'm talking to a CPA later this evening, however. Thank you for the information. – senfo Dec 29 '10 at 12:36

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