Limited liability companies (“LLCs”) have become the top choice for business owners in Pennsylvania seeking operational flexibility, limited liability, and favorable tax treatment. One of the significant benefits of the LLC structure is the ability to make distributions, payouts of profits, cash, or property, to members. Yet the rules for LLC distributions are more nuanced than many entrepreneurs and even some advisors realize. Understanding Pennsylvania law on this topic is essential for compliance, risk mitigation, and sound business planning.

What Exactly Are LLC Distributions?

Definition of Distributions

In an LLC, a “distribution” refers to the payment of money or property by the company to its members (owners). Distributions are typically made out of profits but can also include returns of capital or other assets. Pennsylvania’s LLC Act defines and governs both interim and liquidating distributions, those made during the ordinary course of the company’s life, and those made as part of winding up after dissolution.

Default Rules for Distributions

Equal Shares Unless Otherwise Agreed

Pennsylvania’s LLC Act provides default rules for distributions among members. Unless an LLC’s operating agreement states otherwise, all distributions before dissolution are shared equally, regardless of each member’s capital contribution or ownership percentage. This means that if three members form an LLC and never sign an operating agreement, each has an equal right to distributions, even if one contributed far more capital at the outset.

However, most well-drafted operating agreements customize the distribution scheme. Common alternatives include proportional (pro-rata) distributions based on percentage ownership, preferred returns for confident investors, or other formulas tailored to business realities. The key is that Pennsylvania (like most states) allows significant flexibility, but absent an agreement, the statute mandates equality.

When Are Members Entitled to Distributions?

LLC members in Pennsylvania are not automatically entitled to regular distributions. Instead, distributions are made only when, and if, the company decides to declare them. This is usually handled by the managers (in manager-managed LLCs) or by the members themselves (in member-managed LLCs), in accordance with the operating agreement’s decision-making procedures.

Additionally, while members have a right to expect distributions as the company prospers, they generally cannot force the company to make a distribution unless the operating agreement or a specific event (such as an express provision triggered by profits, a milestone, or a member’s exit) so requires.

Form of Distribution: Cash vs. Property

Cash Is the Default

Another statutory default: Members are entitled to distributions only in cash, unless the operating agreement provides otherwise. Distributions of property “in kind” (such as real estate, equipment, or inventory) are permitted but require careful handling. If assets are distributed in kind, each part must be fungible, and every member must receive a fair and proportionate share of value.

The Insolvency and Balance Sheet Tests

Thoughtful business planning isn’t the only constraint on LLC distributions in Pennsylvania. The law imposes two necessary financial “tests” for every distribution:

  • Insolvency Test: After making a distribution, the LLC must be able to pay its debts as they come due in the ordinary course of business.
  • Balance Sheet Test: After the distribution, the LLC’s total assets must be greater than the sum of its total liabilities and the amount that would be needed to satisfy any preferential rights on dissolution.

If a distribution would violate either of these tests, it’s prohibited by law, no matter what the operating agreement says. Violations can result in personal liability for managers or members who approve illegal distributions. That said, these tests are not typically implicated in an ongoing business.

Recordkeeping and Decision Dates

Pennsylvania law also specifies “record dates” for distributions. In general, the effect of a distribution is measured on the date specified by the LLC when the distribution is authorized (so long as it’s made within 125 days), or on the date of distribution if later.

Proper documentation, including meeting minutes, consents, and updated financials, is essential for both compliance and resolving any disputes down the road.

Distributions Upon Dissociation and Transfer

Transfers of Membership Interests

If a member transfers (sells or assigns) their interest in an LLC, the recipient (transferee) gains only the “economic rights” to receive distributions, not the right to participate in management, unless the operating agreement or consent of other members provides otherwise. This distinction between “governance rights” and “economic rights” is crucial; it affects succession planning, creditor recoveries, and more.

Member Dissociation

Upon a member’s dissociation (voluntary or involuntary departure), Pennsylvania law gives that person the right to either:
(a) receive distributions as provided by the operating agreement, or
(b) within a reasonable time, receive the fair value of their interest as of the date of dissociation.

Charging Orders: Creditor Remedies

Sometimes a member’s creditor seeks to intercept distributions (for example, following a judgment or a divorce). Pennsylvania law specifies that a creditor’s sole remedy is a “charging order,” which gives the creditor a lien on the member’s distribution rights, but not management rights. The LLC must pay any future distributions attributable to that member’s interest to the creditor. Still, the creditor cannot step into the member’s shoes for voting or decision-making. Doing so would be unfair to the other members, who went into business with that member, not the creditor.

Taxation Considerations

While LLCs are pass-through entities by default for federal and Pennsylvania tax purposes, the timing and amount of distributions do not always track the allocation of taxable income. Members may be taxed on their share of profits even if no distributions are made. Business owners need to consult with a tax professional on the interplay between distributions, income allocations, and cash flow planning. For more information on tax distributions, see our discussion here.

Best Practices for LLCs

  • Use an Operating Agreement: Define how, when, and in what amounts distributions will be made.
  • Monitor Solvency: Be cognizant of the insolvency test and the balance sheet test when making distributions.
  • Keep Clean Records: Document every distribution decision and maintain up-to-date financials.
  • Consult Professionals: Work closely with legal and tax advisors to avoid missteps.

LLC distributions might seem straightforward, but Pennsylvania’s rules and the high stakes for noncompliance mean that careful planning and legal guidance are essential. For tailored advice and help drafting or amending your LLC’s operating agreement, contact Spengler & Agans for a consultation today.

Speak to Spengler & Agans Now

Attorney Nathan Wenk at Spengler & Agans is available to assist if you want to ensure your LLC’s distribution rules comply with Pennsylvania law and support your long-term business goals. Contact us online to get guidance tailored to your business needs.