Are distributions from an LLC or an S corporation taxable to the owner?

January 31, 2023

Kinda, but not really. Here we’ll explain how it works and the tax consequences to watch out for and how to avoid problems.

Distributions show up on the balance sheet and are a reduction of equity. Equity includes the original amount of capital you put into the company to start the business and retained earnings which are the accumulation of all your prior years profits and losses.

We call them distributions when you have an LLC or S corporation which are pass-through entities that may be beneficial to your tax situation. When a C corporation returns money to its shareholders, its called a dividend and is just like any dividend you receive in your brokerage account from your Wall Street investments.

In this article we’ll focus on owners of LLCs and S corporations.

When you have a business, you are taxed on the profits of the business. Net profit is your total sales minus all of your business expenses and deductions. So even though distributions are a way of returning money back to you, they are not directly taxable. You can take all of the money out of the business checking account or none of it, you will still only be taxed on the profits.

And when you have an LLC or S corporation, this income passes through to your personal tax return and gets added to any other income that you earned during the year to become your taxable income.

Now here’s a bit of a twist. There’s also a concept of what’s called Shareholder Basis. This is a tax term that is very similar to the accounting term of equity. It represents the total amount of investment you made into the business plus accumulated profits but can also be affected by money you lent to the business. Think of this as similar to the amount of equity you have in your house, you can’t take out more money than the equity unless the value of the house goes up.

And since 2018, the IRS has mandated that all shareholders track their basis and report it to the IRS.

Why is shareholder basis important? Well, if you take out more money as distributions than what you have as basis, then the IRS requires you to report this as a dividend and pay capital gains tax on it. This is not something you want to be surprised by because of improper planning. We’ve seen clients come to us that unnecessarily paid taxes because of bad planning. In one case a business owner paid $15,000 more taxes than needed.

So, in summary, distributions are not taxable, only the profits from your business are taxable. And you want to watch out that you don’t take out more distributions that what you have as basis in your business.

Most problems can be avoided with proper planning and with our proactive tax advisory relationship, we help client understand tax concepts and recommend strategies to save thousands of dollars in taxes.

On average, we help our clients save $54,238 in taxes. We’re able to do this by working with you throughout the year and not just at tax time. Our proactive relationship starts with an upfront tax plan to help you identify tax and business strategies supported by IRS code and court cases. There are thousands of strategies out there that successful companies and wealthy individuals are using, and we will help you find tax savings ideas that are right for you.

This article is for informational purposes only and was current at the time of writing. Tax laws change all the time. To find out if this is an idea that can help your business, schedule a meeting with us.

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Kaufmann Advisors is a California based accounting firm with offices in San Francisco and Los Angeles.
We specialize in working with US-based and international businesses.
Our CPAs and accountants can help you with your bookkeeping, tax planning and tax preparation needs.
We can help you setup your QuickBooks and customize your chart of accounts so you can better understand your business performance.

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