I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
Will I Have to Pay Tax on That Distribution?
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I met with a young business owner this week - one of his questions is the most common ones I get asked all the time. "I took out $150,000 from my business, so I'm going to have to pay tax on that right?" The answer in his case was, "you already have." He stared blankly back at me and we ran through this concept π When a Distribution is TaxableIf you own a "pass-through" business (you get a K1, or are a sole proprietor) then you get taxed income of the business whether you take out a distribution or not. In his case, he'd already paid tax on that income in 2025 so there was no tax due on distributing "already taxed" money. But not every distribution is like this. Here are a few types of distributions that could trigger tax:
You already know - let's dig into each one in plain English. π Preferred Returns as Guaranteed PaymentsThese usually happen in "different classes of equity" - very popular in real estate. Investors are promised a preferred return on their capital invested - call it 8% - and then after that 8% is achieved, the sponsor (GP) receives rights to larger distributions (called a promote). The part that many tax pros miss is the tax treatment of that preferred return. If the operating agreement indicates it is accrued and payable regardless of entity income or profits, then that's treated more like an interest payment to them (like they're a bank). Those payments then go on a different line on the K1 (Box 4) and are taxable to that partner. Distributions in Excess of BasisThis is where "type of entity" really matters. βοΈ Partnerships are great for distributions that are financed with debt. S-Corps are terrible for this kind of distribution. Partnerships give investors and owners "debt basis" - so even if your "capital" is negative, if you have liability allocated to your K1, you don't pay tax on that distribution. (This gets tricky quickly, so be wary of the nuance) S-Corps definitely don't work like that, if you take out a distribution and have no "capital" or "equity" - meaning all or a part of that distribution was financed with that debt - then that distribution is taxable. Disguised SalesSaved the best for last. π₯Έ Years ago, there was a popular tax court case for the sale of the Cubs. The seller worked with the buyer to try to shield some of the sales price via a leveraged partnership distribution. The surprising part of the case wasn't that some of the payout was taxable - it was that a substantial part of it was held as not taxable (deferred). Disguised sales happen when property is contributed to a partnership with another investor and then soon after a distribution is taken by the partner that contributed property (2 years). The Cubs sale took advantage of a caveat to that rule - when the distribution is from legitimate debt. But I see this happen many times for people sitting on old valuable land - thinking they can just drop into a JV and take cash out immediately. It does not work like that. The TakeawayIf you're still staring blankly at the screen - know that we can help. Because whether you owe tax on the distribution you just took or received can be nerve-wracking. Happy 4th of July πΊπΈ π¦ π½ π«‘ New episode of Today in Tax Court just dropped this week - going into the history of HOW we got the income tax. From Articles of Confederation to Civil War to Constitutional Amendment. If you like history, it's a great look back at our country's history and where it all went wrong π€£
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I've been a CPA for nearly 20 years - serving private small business and real estate the entire time. I take the lessons learned in serving and now running a small business and share them here. For business owners, investors, and advisors looking to lower their cost of capital, subscribe for delivery straight to your inbox π Also on YouTube at PlugAccountingandTax!
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