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K1 taxable income versus distribution

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  • K1 taxable income versus distribution

    Hi,

     

    I received a K1 for 2018 that is saying I have a taxable income from the partnership of 140K, but I only received a distribution of about 107K that year. What could account for the difference in amounts? I do not think I have a capital investment of 33K into equipment or any kind of loan to the practice to account for this discrepancy. What are the possibilites to account for the $33K difference? Is this kind of discrepancy typical/reasonable?

    Thank you.

  • #2
    I am more familiar with how this works in an S corp but assume its the same for a partnership

    as a pass through entity, all income of partnership is passed through to partners and reported on K1, whether distributed or not.

    this increases your basis in the partnership, which means that this amount of income already taxed to you, comes out later tax free

    ask your accountant for a basis worksheet

    Comment


    • #3
      It is the same idea for a partnership.  You pay tax on what you're allocated rather than what you're distributed.

      There will nearly always be a difference in the distributions you receive compared to your "distributive share" of the partnership income, deductions, and credits.

      When you're allocated income without a corresponding distribution, we call it "dry income".  Many partnership agreements contain a provision that says each partner is entitled to distributions of at least a certain percentage, usually 40%, of their income allocation.

      Distributions themselves are tax-free to the extent you have basis in the partnership.  Your partnership basis is increased by the capital you invest, the income allocated to you, and your share of any partnership debt.  It's reduced by losses allocated to you, distributions, and a reduction in your share of partnership debt.

       

       

       

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      • #4
        So when there is dry income on the K1 - where is that money physically? In the business ? In some sort of capital assets ?

        Comment


        • #5
          There are many things that create a distribution/allocation difference.  They can include -

          1. Kept for working capital

          2. Invested in capital assets

          3. Used to pay down debt (The payment of debt principal leaves less cash for distribution but is not deducted)

          4. Depreciation expense (this swings it the other way where there's more cash than income.  Often in real estate deals there will be losses allocated but cash distributions because of the large non-cash depreciation expense)

          5. Non-deductible expenses, like entertainment or 50% of meals


           

          Comment


          • #6
            Partnership dist’s are not exactly equivalent to those of s-corp’s.

            • In a partnership, you are subject to FICA taxes on all of the income allocated to you (based on the partnership agreement, the most important document), whether or not you receive it or not.

            • In an s-corp, only wages paid to you are taxed for FICA purposes. The remainder of the profits, whether or not distributed to you (depends on your s/h agreement) are not subject to FICA taxation.


            Fwiw, if you are assuming “distributions” are synonymous with “guaranteed payments (GPS)”, you are making a mistake. GP’s reduce the amount of income allocable to your section 199A calculation. I suspect many partnership agreements have been rewritten (or are, hopefully, in the process) as a result of TCJA 2017. I posted a thread about this recently but it didn’t gain much traction.

            Your partnership agreement is far more consequential (impo) than the shareholder agreement of an s-corp.

            • S-corp distributions must be proportional to s-corp ownership or the business is subject to loss of s-corp status due to the 2nd class of stock regs. Partnerships are far more flexible; profits/losses are allocated according to the specifications of the partnership agreement.

            • Partners can benefit from “UPE (Unreimbursed Partner Expenses)” deductions if the partnership agreement is appropriately written while s-corp owners must have an “accountable plan” in place to deduct business expenses paid personally on behalf of the business.

            Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

            Comment


            • #7
              It is actually not a partnership. We are a S-corp.

               

              Is it a red flag in a S-corp when the cash distributions are not close to the taxable K1 income? Should are firm CPA be able to tell me pretty quickly and easily why there is a 37K discrepancy/phantom in come in my case?

               

              Thanks for the information.

              Comment


              • #8
                I think it's worth asking about.  There could be reasons why the S-corp is keeping cash rather than distributing it.

                I'd make sure the distributions have been done and reported pro-rata.  I'd be concerned if the distributions are not being done pro-rata more than I'm concerned that the S-corp is holding onto its cash.

                Comment


                • #9




                  It is actually not a partnership. We are a S-corp.

                   

                  Is it a red flag in a S-corp when the cash distributions are not close to the taxable K1 income? Should are firm CPA be able to tell me pretty quickly and easily why there is a 37K discrepancy/phantom in come in my case?

                   

                  Thanks for the information.
                  Click to expand...


                  Yes, the firm’s CPA should be able to sit down and explain this to you quite easily. This part is not rocket science (or brain surgery?).
                  Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                  • #10
                    not really a red flag. Yes the CPA should be able to answer this.

                    a possible scenario is simply that the amount of actual income exceeded the amount of predicted income. Who determines how much you're taking in distributions? When is this determined? How often during the year is this reviewed?

                    Ask for your basis worksheet.

                    Comment


                    • #11
                      I am wondering if this has to do with being a partial shareholder. Due to the structure of the business with limited shareholders (which eventually become full equal shareholders with time) my understanding is the amount of year end earnings in the distribution (at year end) is limited by the equity percentage of the lowest shareholder. So, I wonder if my total compensation including W2 income + the distribution I received is correct, but I might be expected to pay the tax on this 'phantom income' from my W2 earnings. I was the lowest equity shareholder this particular year.

                      Comment


                      • #12
                        distributions in an S corp must be proportional to ownership. Where this usually creates issues is when a shareholder is due overall less compensation (working part time, lower production, etc) but still has a full ownership share. Once they're paid a reasonable salary and other benefits and allocated expenses are deducted from their share of overall comp, they don't have much left for distribution. Then everyone else's distribution has to be reduced down to this "lowest common denominator"

                        not quite the same as your situation

                        specifics matter. Talk to your CPA, practice manager, someone will have answers

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