Like stock options, the granting of interest on earnings at the time of award should not lead to a taxable event for the beneficiary. Unlike stock options, the recipient of an interest rate is not required to pay an exercise price to obtain the interest on shares represented by the interest on the profits. Once the interest is collected, the beneficiary is a member of the LLC (an option holder has only one option to acquire shares and is a shareholder only when he exercises his option and pays the exercise price). Like stock options, interest on earnings may be subject to a stock lease. Vesting can be either time-based or performance-oriented, so that the recipient seizes equity while continuing to provide services to LLC, or achieves certain performance goals set by LLC management. A beneficiary of a profit-sharing contribution can no longer be considered an employee of the LLC for the purposes of federal income tax. Instead, as soon as the recipient receives the interest on the profits, he or she must be treated as a “partner.” This means that instead of withholding income and employment taxes from their paychecks and obtaining a W-2 form, they must instead make quarterly tax filings as self-employed, pay taxes on self-employment and receive a K-1 form from the LLC. On the other hand, a beneficiary of a stock option retains employee status and receives a W-2 that discloses salary/deduction information. If you want to give employees an incentive for equity, but do not want them to be no longer used for federal tax purposes, you can issue equity to a separate company that was created for that purpose. It is expensive and more administratively expensive, but workers generally prefer to charge taxes on their paychecks on their behalf. LCs do not spend “shares” but “affiliate interests” or “units.” Most MCS, which has multiple members, are taxed as partnerships for federal tax purposes and do not choose to be taxed as an organization. For LCRs that are taxed as partnerships, the next equivalent of a stock option in a business is called a “profit rate.” If you give a person a share in the profits of an LLC, that person receives a stake in both the future profits of LLC and in the valuation of LLC`s assets.
Since the beneficiary of the interest on the profits receives only a share in the future profits of the LLC and the revaluation of the LLC`s assets, the interest on the profits, if properly realized, should not give rise to taxable income on receipt at the time of the award. For example, if you benefit from a profit share of an LLC equal to 5% of LLC`s outstanding equity, you are entitled to 5% of LLC`s earnings after the date you received the interest on the profits.