Are you the owner or shareholder of a limited liability company (GmbH)? Then you are entitled to a share of the company’s profits.
But how does the actual distribution of profits work? Are any shareholders’ resolutions necessary for this or can you simply have your share of the profits paid out to you?
And: How is the payout actually taxed?
In my practice as a tax consultant in Hamburg I deal with these questions almost daily. Company owners come to me seeking my advice on how to handle these issues in a legally compliant way and to their best advantage.
That is why, in this blog post I would like to demystify the issues.
In less than ten minutes reading time you will learn:
- What the difference between profit distribution and profit allocation is
- How profit distribution is taxed
- What three common mistakes company owners make when distributing profits
What is the difference between profit distribution and profit allocation?
Allocation of profits: Here, the profit is simply divided among the shareholders. The basis for this is usually the share one holds in the company.
For example, if you hold 50% of the shares in the company, you are entitled to 50% of the profits.
However, a so-called disproportionate allocation of profits can also be stipulated in the articles of association. In this case, a different distribution ratio can be determined by means of a resolution.
For example, this could be as follows: You and your business partner each hold 50% of the company.
Since your work was instrumental in generating the high profits this year, you and your partner decide to divide the profits 75% to 25% in your favor.
However, a disproportionate allocation of the profits can also be made for tax reasons.
Please note: Profit allocation only determines how profits will be divided among the partners and not how the profits will be used.
Profit distribution: If the shareholders decide to have the profits paid out, profit distribution comes into play.
The majority of the shareholders have to pass a resolution for the profit distribution.
Only then can the profit be paid out to the individual shareholders.
Without a profit distribution resolution, the profits remain in the company. This is also called profit retention.
How is the distribution of profits for a GmbH taxed?
There are two possible options for taxing the distribution of GmbH profits:
Option 1: Capital gains tax
In this case your profit shares are taxed at a flat rate of 25% when they are paid out (see Section 43a German Income Tax Act (EStG)).
The solidarity surcharge and, when applicable, church tax are added to this 25%. In total the tax rate amounts to between 26.3% and around 28%, depending on the particular church tax.
Option 2: Personal income tax (partial income method)
With the partial income method, your share of the profits is not taxed as capital gains, but according to your personal income tax rate.
However: Only 60% of your share is actually taxable with this option. The remaining 40% is not taxed.
Nevertheless, the prerequisite for the partial income method is that you either hold a 25% share in the GmbH or have a share of at least 1% and are active in the company at the same time.
Please note: You cannot switch between these two options from year to year. If you apply for the partial income method, it remains valid until revoked.
Which of these two options is best for you can probably only be answered by your tax consultant.
These three mistakes are often the downfall of limited liability companies when it comes to profit distribution
Mistake 1: No profit distribution resolution
Profits are often distributed without a profit distribution resolution, especially in the case of smaller and medium-sized GmbHs. Caution: Even if you alone hold all the shares in your GmbH, you need to have a resolution.
In this case the resolution is only a formality, but it is often forgotten in practice. The result: You make yourself liable for prosecution with a hidden profit distribution and in the worst case can even end up in prison.
What exactly a hidden profit distribution is and the three ways to avoid it are summarized for you in a separate blog post: https://www.steuerberatung-breit.de/hidden-profit-distribution-this-leads-to-you-or-your-company-being-liable-to-prosecution/
Mistake 2: Distributing profits in the wrong sequence
If you use the partial income method, it is important to adhere to the following principle: The distribution of tax-free profits is only possible when all taxable earnings have been paid out.
If you do not adhere to this legally prescribed sequence, you will probably have to pay a fine.
Mistake 3: Lack of a distribution plan
If you have accumulated substantial profits over the years that have not yet been paid out, you should prepare a distribution plan.
In this distribution plan you determine over which period (for example 5 or 10 years) you will distribute the profits in order to keep taxation as low as possible.
If you distribute the accumulated profits all at once, your taxation will generally be higher than if you distribute them over several years.
However, such a distribution plan only makes sense if you actually want to pay out the profits.
If the profits are to remain in the GmbH, you do not need a distribution plan.
Conclusion: Planning prevents penalties and excessive taxes when distributing profits
In order to keep your tax burden as low as possible and to avoid penalties for a hidden profit distribution or similar offences, profit distribution must be planned precisely.
When handling significant profits or a complicated ownership structure with several shareholders, it is worth asking a tax consultant for advice. As everyone knows, the complexity of the German tax system is a minefield, which makes it difficult to carry out profit distribution in a legally “clean” way so that you save tax and avoid any legal traps.
Therefore, for you as the owner of a small or mid-sized limited liability company seeking the advice of an experienced tax consultant is the only sensible way.
Without expert advice, you can very quickly slip into the legal pitfall of hidden profit distribution and possibly end up in prison.
Do you have any more questions about profit distribution?
Perhaps the information in this article has cleared up your biggest questions about profit distribution. Maybe, however, you would like more details? Would you like to know the best way to distribute profits in your particular company?
You are welcome to contact me about these or other questions.
You can reach me at any time by phone (+49 040 443311), e-mail (anfrage@steuerberatung-breit.de), via my contact form or at my tax consultancy office in Hamburg.
Kind regards,
Thomas Breit
Photo: © motortion – stock.adobe.com
