{"id":15793,"date":"2022-03-01T14:39:39","date_gmt":"2022-03-01T22:39:39","guid":{"rendered":"https:\/\/evergreensmallbusiness.com\/?p=15793"},"modified":"2022-02-14T08:15:53","modified_gmt":"2022-02-14T16:15:53","slug":"pulling-profits-out-of-your-business","status":"publish","type":"post","link":"https:\/\/evergreensmallbusiness.com\/pulling-profits-out-of-your-business\/","title":{"rendered":"Why Profit Distributions Usually Don’t Get Taxed"},"content":{"rendered":"

\"How<\/a>We encounter a common misconception from flow-through business owner clients\u00a0 every year and I want to try and clear the air.<\/p>\n

That misconception? That distributions from partnerships, S corporations and other pass-through entities get taxed. (They usually don’t, by the way.)<\/p>\n

The misconception regularly leads to a minor financial tragedy. Because often times a business owner sits on a huge cash balance in their business checking account. That money, they actually need<\/em> to use on, you know, life things like rent or mortgage payments, insurance, taxes, day care, food, clothing, vacations and so forth.<\/p>\n

But the business owner doesn’t want to distribute the profits. Because she or he fears paying tax on the money. Which is ironic. And wrong.<\/p>\n

So this article explains what’s going on here. I’ll discuss what you get taxed on. When you get taxed. I’ll explain how the mysterious thing the accountants call “basis”works. And then I’ll end with a warning about a common error you want to avoid because it unnecessarily triggers additional taxes.<\/p>\n

To start, a quick discussion about taxable income and basis…<\/p>\n

Taxable Income from Your Business<\/h1>\n

Each business entity type calculates taxable income in basically the same way. Taxable income equals taxable revenues minus deductible expenses. This number gets reported in box 1 of the K-1 form you receive from the business, which in turn gets plugged into and taxed on your individual 1040.<\/p>\n

For example, you start a business at the beginning of the year and collect $100,000 of revenues and pay $50,000 of deductible expenses.\u00a0 Your business’s taxable net income at the end of the year equals $50,000. Suppose you only used the revenue you collected to pay the business expenses and now have $50,000 in your business checking account.<\/p>\n

Money left over in the bank is the confusing part. Because you might think you avoid taxes on this money if you leave it in the business. And that you only pay taxes on the money when you take it out of the partnership or S corporation or sole proprietorship.<\/p>\n

But that’s not the way the accounting works. You pay taxes on the business profit. Not, usually, on the distributions of profit paid to an owner.<\/p>\n

Now let’s have a quick chat about basis.<\/p>\n

Basis and Why It Matters<\/h2>\n

I want this discussion to remain as simple as possible. (If you would like to dive deeper, you can read the statute for S Corporations here<\/a> and the statute for Partnerships here<\/a>.) But to generalize, a business owner’s basis consists of the cash and adjusted-for-depreciation cost of property contributed to a business, adjusted for certain items that increase and decrease said basis.<\/p>\n

Let’s look at the common increases and decreases…<\/p>\n

Increases to Basis:<\/h4>\n