Contributing services to an LLC in exchange for ownership

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People make LLC Capital Contributions in order to become LLC Members (owners of the LLC).

In addition to being exchanged for LLC ownership, Capital Contributions also “capitalize” (fund) your LLC. Meaning, they give your LLC the money it needs to operate, pay expenses, and ideally, become profitable.

Capital contributions can be made in the form of:

  • money,
  • personal property, or
  • services.

While contributing money is the most common form of Capital Contribution, LLC owners may also contribute services (aka “sweat equity”).

These services must be non-related labor. Meaning, the labor being contributed isn’t a part of the LLC’s main business activities.

An example of Service Contributions to an LLC

Paul and Fatima are starting a business called Pita Truck LLC. They each own 50% of the LLC. And they each agree to contribute $5,000.

Both Paul and Fatima have a culinary background, however, Fatima also used to work as a food photographer and graphic designer.

For his initial Capital Contribution, Paul will contribute $5,000 cash.

For her initial Capital Contribution, Fatima will contribute $500 cash and her photography and design services.

She’ll shoot all the photos for the website and social media. She’ll also design the logo and other digital branding. These services are valued at $4,500, which is what she used to charge clients.

After the photos and design work are done, both Paul and Fatima will work in the business and run the day-to-day operations of the food truck together.

How to determine the value of a Service Contribution to an LLC

If you are contributing non-related services to an LLC for ownership, you’ll need to figure out the fair market value of those services.

The fair market value is what it would cost to hire someone else to do the same work. To determine this, you can do online research or get a few quotes from similar service providers.

Once the value is determined, it’s best to make sure all the LLC Members agree.

Documenting service contributions to your LLC

Service contributions in exchange for LLC ownership should be documented in your LLC Operating Agreement.

You may need to customize your Operating Agreement to document your service contributions. If you need assistance, we recommend hiring a business attorney for help.

You should also give a record of this Contribution to your accountant. Call your accountant and ask what they need in order to document the Contribution.

What’s the tax treatment of contributing services in exchange for LLC Ownership?

Tip: Most people contributing services in exchange for LLC ownership won’t be taxed on the value of the Membership Interest they receive. That’s because the Service Contributions are most often initial Capital Contributions in new LLCs.

To better understand this, let’s go over some basics about exchanging services for LLC ownership (aka Membership Interest) and how that might be treated as “income”.

  1. Membership Interest in an LLC means that you own part of the business.
  2. Membership Interest itself may have value (or it might not).
  3. If your Membership Interest has value, the IRS will consider exchanging services for it to be “income”.
  4. You must pay taxes on income.

Said another way:

  • If your Membership Interest has value, it’s income, and you owe taxes.
  • If your Membership Interest doesn’t have value, it’s not income, and you don’t owe taxes.

How do I know if my Membership Interest has value?

The easiest way to determine this is by using the “new business test”.

Meaning, if your LLC is brand new, then the business itself doesn’t have value yet. And therefore, your Membership Interest doesn’t have value either.

Ask yourself this question: What would someone pay for your LLC today? For most people with a brand new LLC, a buyer wouldn’t pay anything ($0) for the business. This is because the LLC isn’t generating substantial revenue yet, and doesn’t have many assets.

For example: Jane owns 50% of a business that is worth $0 (because it’s brand new). And although she traded her services to get that 50% Membership Interest, her Membership Interest is still worth $0. And therefore she doesn’t owe taxes.

LLCs that don’t pass the “new business test”:

If you are exchanging services for Membership Interest in an existing LLC, then the LLC likely won’t pass the “new business test”. And the Membership Interest you receive will be considered “income”.

That’s because this LLC likely already generates a profit and has cash in the bank. It might also own real estate, inventory, or equipment. A business like this has a real market value (it could be sold).

Therefore, the Membership Interest you receive (in exchange for your service) will be considered “income”. And therefore, you’ll need to pay taxes on the value of that “income”.

For example: Bob is going to exchange his labor as a carpenter (building tables and chairs) to become a 25% owner in Lotus Bistro LLC. Because Lotus Bistro LLC is valued at $200,000, the Membership Interest Bob receives is worth $50,000. And the IRS considers this $50,000 in “income” and therefore, Bob will pay taxes on that $50,000.

Okay, I kind of get it… but will I have to pay taxes?

If you are contributing services in exchange for LLC ownership as an initial contribution in a new LLC, you don’t owe taxes on that contribution.

If you are contributing services in exchange for ownership in an existing LLC, you should talk to an accountant because you may owe taxes.

Other types of LLC Capital Contributions

Besides contributing services to an LLC, Members can make LLC capital contributions and/or contribute personal property to an LLC.

Matt Horwitz
Matt Horwitz
Matt Horwitz has been the leading expert on LLC education for the past decade. He founded LLC University in 2010 after realizing people needed simple and actionable instructions to start an LLC that other companies weren't offering. He's cited by Entrepreneur Magazine, Yahoo Finance, and the US Chamber of Commerce, and was featured by CNBC and InventRight.
 
Matt holds a Bachelor's Degree in business from Drexel University with a concentration in business law. He performs extensive research and analysis to convert state laws into simple instructions anyone can follow to form their LLC - all for free! Read more about Matt Horwitz and LLC University.

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10 comments on “Contributing services to an LLC”

Disclaimer: Nothing on this page shall be interpreted as legal or tax advice. Rules and regulations vary by location. They also change over time and are specific to your situation. Furthermore, this comment section is provided so people can share their thoughts and experience. Please consult a licensed professional if you have legal or tax questions.

  1. Hello Mark,

    Thank you for that great info. I’m starting a franchise business and I have partnered with a friend who is experienced in business planning and managing. I injected $85 K and we are getting a loan for the startup of > $350K to purchase equipment, kiosk and other startups. We will have $50k operating capital from the loan and any savings from the loan might be added to the operating capital. We agreed I get 65% and he gets 35% of shares in exchange for his services in starting the business (online meetings with franchisor and lender, getting tenders from manufacturers to negotiate, etc). We will treat my contribution as loan to the LLC. I suggested for that to have it paid back to me over 5 years ($1,500 per month). but he is worried the profits might not be so high specially at the beginning so I suggested we get salaries from the working capital as owners from the working capital for 3 months before opening and may be if the cash flow goes well to take salaries for few months after opening.

    I would like to know :
    1. Is this well planned? Appreciate any comments/suggestions.
    2. Should I make just a profit sharing agreement? Or better he receives profits and equity?
    3. I think I should write a promisory note from the LLC to myself for the loan of $85K am contributing. What other forms I need to file ?
    4. Can I get my loan installment at the first months of opening from the operating capital or overhead savings from the loan or this is not legitmate?

    Appreciate your valuable feedback.

    Best regards,
    Mike

    • Hi Mike, you’re welcome. First, for an LLC taxed in its default status, you actually can’t take a W-2 salary. Additionally, this is really hard to comment on. Reason being it’s vastly complex and nuanced. And even if we did have more details, it’s beyond the scope of the support we can provide. In this scenario, I recommend hiring an experienced business attorney to draft a custom Operating Agreement and any supplemental documentation. You may need to speak to a few attorneys to find one who’s a good fit. Hope that helps, and thanks for your understanding.

  2. Hi Matt, Thanks for the great information and website. My wife and I own a motel property and plan to use our new LLC as the management company. We will keep the real estate and most of the business property assets in our personal names and lease them to the management company (LLC). We would like to include our Managers as LLC Members so they can benefit from profit and have an “ownership” position. The only assets the LLC will own is the cash on hand and the day to day supplies. We would like to include them as a 20% owners without actually getting capital from them. Lets say we decide to fund the LLC with $100,000 to use as cash flow and operating expenses. Could our Managers be given 20% of the LLC without contributing cash? Can the LLC loan them the 20%?

    • Hi Mark, you’re very welcome. The simple answer is yes to both. Yes, the managers can be given 20% without contributing cash (technically, they should contribute something, but it can be a small amount). And yes, the LLC could loan them the 20%. However, there’s other details to consider. First, you don’t have to give someone equity for them to participate in the upside. You could do a profit sharing agreement instead.

      If you do want them to be Members, it’s likely best to hire an attorney to draft a custom Operating Agreement (including buy/sell agreements). And my guess is you may want the LLC to be Manager-managed. Where you and your wife are Managers and the other two are Members. Meaning, they don’t have authority to bind the LLC into contracts or agreements.

      Or maybe you do. I’m just tossing out a few options. I guess something else to consider I just thought of… if this management LLC is paid by you and your wife, is there substantial money to even give to the managers? I guess I’m just thinking out loud here. Many ways to slice the pie. To dive into the details and figure out what’s best, I’d personally chat with an attorney or two.

  3. hello
    i have a question regarding contribution to my LLC. Its’ a single member LLC was open since 2018 but was never generated income. now i start doing a few thing on it that bring a litle bit of money like 500 to 1000$ but at this point i want to contribute money to really start working on the businiss.my question is the fact that the llc was there since 2018 if i contribute money to it will i get tax in return of that money.
    thank you

    • Hey Mitch, congrats on things ramping up :) You can contribute money to your LLC now, and anytime you want. And no, contributions won’t affect how much you pay in taxes.

  4. Hello (Thanks for this website, it is awesome),
    I plan multi-owner LLC to register with three friends in Pennsylvania.
    I have my current single owner LLC, so the new one will be an LLC between (my single owner LLC and three friends represent themselves, they do not have LLCs).
    We agreed that each of them will contibute $4K for 2% of the business (sum to 6%), then I will contribute $20K for 10 % of the LLC. The remaining 84% will be assigned to me since I will take care of everything as the CEO and the main expert on the field. The product is a basically software related and I am a software developer so I will develop part myself and I will create all designs plus supervising and managing the free lancers we will hire to get the product up and and running.

    I was wondering how to write this in the exhibit section that lists the members and their paid considerations?
    Also, how to avoid getting this interpreted wrongly by IRS. Neither they nor I want to pay taxes on nothing. This is just a new company without any assets of any kind. Practically, the real value is zero as we start.

    Thanks in advance

    • Hi Abdo, we don’t provide custom language for Operating Agreements. Instead (and especially with multiple owners), we recommend working with an attorney. Not just for a custom Operating Agreement, but also for buy/sell agreements and any supplemental documentation. Having said that, you could still edit the Operating Agreement yourself and just spell things out in simple English.

      And how much of the LLC each person (or entity) owns doesn’t “get interpreted” wrong by the IRS. To back up one step, a Multi-Member LLC is taxed like a Partnership. And by default, you need to file a 1065 Partnership return every year, even if there is no income. But there won’t be taxes owed. The 1065 is an informational return.

      If there are profits (or losses) to distribute, your accountant would issue K-1s to all the Members. That’s where it would state the percentage of how much of the LLC each person/entity owns. Said another way, you’re just telling the IRS the percentages. The IRS isn’t reading and interpreting your Operating Agreement. Hope that helps.

  5. Hello,

    Back again with some additional inquiries regarding operating agreements. I’ve formed my LLC, which has two members (my spouse and I who will assume 50% ownership each). All of our finances are joint (i.e. the pay from both of our 9-5’s are direct deposited into the same checking account).

    Question 1:
    Is there a legitimate need for an initial capital contribution? The intent was to use money from our personal account to pay for business expenses until the business began generating funds, at which point those funds would be routed to a business account separate from our personal monies, and used to cover future business expenses.

    Question 2:
    If my wife and I both intend to tackle the responsibilities of this venture, is there a requirement to assign a Chief Executive Member? I want to maintain flexibility and feel like that could create unnecessary limitations.

    Thanks in advanced.

    • Hi BW, yes, the capital contribution is known as “consideration” in contract law. It’s what you trade in exchange for your 50% LLC Membership Interest.

      Technically, your capital contribution can be as simple as $100. However, I recommend making it an amount that would fund the business. For example, both you and your wife each contribute $1,000 or $10,000 each. Then pay the business expenses from the LLC bank account, not your personal account. It’s known as commingling of assets when you pay business expenses with personal funds… or pay personal expenses with business funds.

      To avoid this, if you want to pay business expenses, you move money from your personal account into the LLC bank account and then pay business expenses. Or vice versa. To pay personal expenses, move money from the LLC bank account to your personal account and then pay personal expenses.

      And no, there is no requirement to appoint a Chief Executive Member. Hope that helps!

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