Distributions in Excess of Basis Made Simple | Calculated Moves

September 1, 2022

I’m Donna Bordeaux. Let’s talk about distributions in excess of basis.

You cannot take more money out of the company than you put in. Your basis is what income gains and losses have been allocated to you based on your ownership percentage. Plus, any contributions that are made to the business are included.

If you take more money out of the company than you put in, then there are two ways to handle it. Many business owners took out E.I.D.L. loans or received P.P.P. money. That money was never considered income, and they never paid taxes on it. If they took that money out, it caused a gain in excess of their basis. Let’s look at a quick example.

A business earned a hundred thousand dollars, and the owner took out no money. For the sake of the example, we’ll say the basis was zero. At the end of the year before, the basis end of the year is $100,000, and she pays taxes on that $100,000, even though she never took any distributions from the business. A second business earned a hundred thousand dollars in its first year, and the owner took out $75,000 in distributions. She pays taxes on that $100,000 profit and her basis going forward is 25,000. That’s 100,000 less than the 75,000 she took out. A third business owner earned $100,000 in its first year and took out an E.I.D.L. loan of $50,000.

Let’s say the owner took out $130,000 in distributions. She pays taxes on 100,000 in profit as the others did. And her basis was completely wiped out by the 100,000 in distributions. The remaining 30,000 in distributions came from the E.I.D.L. loan money, which has never been taxed. Her basis would be $30,000 negative. This causes a gain in excess of the basis of $30,000. You can choose to treat the excess distribution as a long-term capital gain on your personal tax return. If you have a low tax bracket, it may be better to do this because the gain is taxed at 0%.

Even if you’re in a high tax bracket, it might still be worth it to take the gain, as the maximum tax rate for long-term capital gains is currently 20%. If you have a lot of capital loss carried forward, you could even use them to offset the taxes on that gain. Your second option would be to reclassify the extra money you took out of the business as a loan from yourself. If that loan is more than $10,000, you’ll need to pay it back with interest.

The interest rate is currently very low and set by the I.R.S. If this is considered a loan, there should be a loan document drawn up documenting the repayment schedule and the terms to be sure that it’s considered a legitimate loan. To sum it up, make sure you are aware of how much money you’re taking out of your company so that you don’t have any tax problems. No one wants a surprise tax liability at the end of the year.

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Donna Bordeaux, CPA with Calculated Moves

Creativity and CPAs don’t generally go together.  Most people think of CPAs as nerdy accountants who can’t talk with people.  Well, it’s time to break that stereotype.  Lively, friendly, and knowledgeable can be a part of your relationship with your CPA, as demonstrated by Donna and Chad Bordeaux. They have over 50 years of combined experience as entrepreneurial CPAs.  They’ve owned businesses and helped business owners exceed their wildest dreams. They have been able to help businesses earn many times more profit than the average business in the same industry and are passionate about helping industries that help families build great memories.