A short (~4-minute) YouTube explainer by Donna Genie about distributions in excess of basis. The video defines basis (allocated income/losses plus contributions), gives three numeric examples showing how distributions affect basis (including one where distributions exceed basis because of untaxed EIDL/PPP funds), and explains two ways to handle excess distributions: report as a long-term capital gain or reclassify as a loan (with documentation and interest if > $10,000). It emphasizes monitoring distributions to avoid surprise tax liabilities and includes standard contact/CTA information.
Questions this video answers
September 1, 2022
$100,000
$75,000
$30,000
20%
Chapters
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 into the business are included. If you do take more money out of the company than you put in, then there are two ways to handle it. Many business owners took out Eidl loans or received PPP 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 $100,000 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 at the end of the year is $100,000 and she pays taxes on that $100,000 even though she never took any any distributions from the business. A second business earned $100,000 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 the 100,000 less the 75,000 she took out. A third business owner earned $100,000 in its 1st year and took out an EIDL 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 Eidl loan money which has never been taxed. Her basis would be $30,000 negative. This causes a gain excess of 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 a maximum tax rate for long term capital gains is currently 20%. If you have a lot of capital loss carryforward, you could even use them to offset that 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 irs. 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're aware of 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. Please follow us on Facebook and Instagram. Please make sure to check out our blog and our website linked below. Subscribe to our YouTube channel and hit the bell to be notified when we post. You can email me@donnaampgroundaccounting.com.
