Owner Draws - Taxable in an LLC?

I'd like to see an answer to this too from someone knowledgeable. I thought I understood that owner draws were from the company profits and were taxable as ordinary income whether or not they were actually distributed to the members. However I saw in another post that owner draws are NOT taxable? Now I'm confused.

http://quickbooksgroup.com/web...

I have found some things out on my own since I posted this. It all depends on how the LLC is formed - as a partnership, Sub-S, etc. If it is formed as an LLC partnership, owners take draws - not sure how it's taxed yet. If it is filed as a Sub-S Corporation, all owners must take a reasonable wage & need to pay self employment taxes (FICA, Medicare, Social Security).
I would confirm all of this with your accountant, of course. Hope this helps.

It depends on how you set-it up.

Each owner of an LLC (taxed as a partnership) will get a K-1 reporting his or her income or loss for the year which will then go onto the 1040.

If a draw is taken it is not taxed in addition to the income on the K-1 if the person taking the draw had enough basis to take the draw. Basis is created through investments into the business plus profits and reduced by draws and losses in the business. If the draw is in excess of basis the excess amount will be taxed.

Also, if the draw is for compensation it will be considered a Guaranteed Payment and will be recorded as income on the K-1.

Technically owners of an LLC should not take W-2 wages throughout the year. Although it is a common practice and at the end of the day the tax paid is the same.

Is the mud any clearer? Partnership taxation can be complicated and confusing. If you have any questions it is well worth consulting a CPA to make sure you are doing it correct

I am still confused!! We formed a three partner LLC last year and only two of the partners made equity investments, which I recorded in individual equity accounts for each partner. The partner who did not make an equity investment took several draws against his equity account, which started at zero, so his equity was negative at the end of the year. When I ran the K-1, he had no income to report, only his share of the losses (we spent a lot of money last year but made little income). How do I show his draws as misc income??? Or do I??

As long as you are reporting his negative capital account correctly on the K-1 he will be responsible for picking up any income related to a negative capital account on his personal return. You would not deal with it on the LLC level.

Hello -

An LLC that is treated as a disreguarded entity or a partnership allows owners to take draws. That means owners are not treated as employees and are not issued paychecks. They take draws just like a sole proprietorship. The draws are listed under the equity account for each partner. The Equity accounts show up on the Balance Sheet not on the Profit Loss Statement. Each partners equity account should have two sub-accounts - one for investments and one for draws.

If the LLC is treated as a corporation (C or S) then the owners are paid as employees. That requires all the withholding and payroll tax reporting.

So in your case, draws are they way to handle owner payments. The partner that didn't contribute equity but took draws will be stated on the tax return and the resulting Schedule K-1. Each partner is responsible for his/her own taxes at the end of the year. Your LLC is a pass-through, partnership. That means the LLC gives all the profit and losses to the partners based upon the percent he/she owns in the company.

> Technically owners of an LLC should not take
> W-2 wages throughout the year. Although it
> is a common practice and at the end of the
> day the tax paid is the same.

Pretty close to right, members (owners) of an LLC that has not elected to be taxed as a corporation should not take W-2 style wages because as W-2 wages they will be subject to federal and state (if any) unemployment taxes. I think that is true for all states, at least it is in Missouri.If they try to exclude their W-2 wages from the unemployment tax because they are owners of an unincorporated business they may not succeed, and at the least someone will ask them why they are doing it.

Other than the unnecessary unemployment tax that is being paid, you are pretty close to right that it is the same.

I think you are mixing up your terms a little -

A draw is an actual distribution, so saying 'draws were taxable as ordinary income whether or not they were actually distributed ......" is not the right way to say it.

The income of the business is taxable, whether distributed or not. Draws (which may be actual distributions) are not always taxable events in and of themselves. A draw that is really a guaranteed payment is usually taxable though.

One way to look at it is to pretend like the earnings are a payroll check that is deposited directly into your bank account. You pay income tax on the paycheck, not on the checks that you write against it. A member of an LLC/partnership pays tax on the earnings that are credited to their capital account, not on the draws that they may take against those earnings.

Hello Suzette - I had a similar question and this discussion went part of the ways towards answering it.

I have a simpler LLC structure - just two partners splitting everything down the middle. Taxed as a partnership.

When you say that the owners each have an equity account with 2 sub-accounts, that makes perfect sense. Then all disbursements to the members/partners come from the draw account. All deposits go into the investment account.

That means if the company is making a profit, eventually we will draw more than we've invested (hopefully) and each partners equity account will be negative. Is that right? And it wouldn't matter if we were taking draws once a month or once a year, they would all be treated the same, correct?

Two more related questions:

1. I know that these draws (and in fact, nothing the LLC does related to profit and losses) has any taxable effect on the LLC and that at year end, the LLC simply reports what happened to each of the partners on the K-1s. But of course these draws (assuming we are earning profits regularly and taking regular draws) have a taxable effect on each of us individually, right?

What I don't understand is how those draws appear to us as individuals - do they somehow show up on the K-1s? Or are we just responsible for reporting them on our 1040s as income??? I'm confused as to this point.

2. Occassionally one of us does work for the company and we pay that person like we'd pay a sub-contractor (we build homes). Is it OK to treat that 'distribution' as a sub-contractor pmt (not a draw) and then issue that person a 1099-MISC at year end.

Thanks very much for your assistance.

Bill

> 1. I know that these draws (and in fact, nothing the LLC does related to profit and losses) has any taxable effect on the LLC and that at year end, the LLC simply reports what happened to each of the partners on the K-1s. But of course these draws (assuming we are earning profits regularly and taking regular draws) have a taxable effect on each of us individually, right?

An answer - Yes and no. The action of taking a draw is generally not a taxable event in itself. It does have a potential future tax impact however by reducing your basis in the LLC. I labeled this as 'an answer' because it isn't always that simple. There are other factors that go into it, usually having something to do with basis.

> What I don't understand is how those draws appear to us as individuals - do they somehow show up on the K-1s? Or are we just responsible for reporting them on our 1040s as income??? I'm confused as to this point.

Answer - Line 19 of Schedule K-1 is used to report distributions. From there, it does not go directly to income but instead goes to a basis calculation.

> 2. Occassionally one of us does work for the company and we pay that person like we'd pay a sub-contractor (we build homes). Is it OK to treat that 'distribution' as a sub-contractor pmt (not a draw) and then issue that person a 1099-MISC at year end.

An answer - I've heard of situations like what you are describing causing a dispute among members of the partnership because there could be a feeling that the sub-contracting member is double-dipping. Other than that, two businesses can do business with each other.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any US tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any matter addressed herein.

Thanks Ed - I thought I had this down, but am confused about 'basis'.

My partner and I have each put $10k into our business (an LLC treated as a partnership). We each took a $20k draw last year. I have both an investment and a distribution account for each partner. Both equity accounts. They roll up to a partner account for each partner. Right now, the partner account shows negative equity of $10k.

Can anyone direct me to a resource where basis in an LLC is discussed in more detail?

Thanks
Bill

Your tax preparer could tell you a great deal, and even better it could be done using your specific information.

In addition, a quick Google search yields a large number of hits:

http://www.google.com/searchie...

(that is, searching on three words: tax basis llc)

You'll learn a lot following some of those leads, but not all of this can be relied on as 'expert' and it won't be tailored to your situation. Once you have some background on it, you'll be ready to talk to your tax preparer.

I neglected to mention our friends at www.irs.gov, the font of all wisdom. You will find many publications there on many subjects. They do try to make it understandable, but it's a pretty thick subject for most people and I've always learned better by reading about the same thing in several publications. Each author has a different way of saying it, and that helps me to understand better.

The PDF file I've uploaded here is one such publication. Look for discussions on partners basis in this one.

Of special (and unsuspecting) note to some is the idea that a partner who gets their partnership share because of some service they provided has taxable income as a result. The special election under Section 83(b) can be a great help.

Also, note that the IRS does not consider their form instructions and publications to be authoritative documents. To get something concrete that you can stand on you have to read the actual code and regulations. The rest of it is there to help you formulate your question and guide your research.

If you are reading this post (or any post about taxes for that matter) on this forum at some point in the future please be aware that things do change, and that you should always look for the thing that is most relevant to your current date and situation that you can find. Talking to your tax preparer is an excellent start.

Easy Answer:

No, Income Taxes are not filed/paid on distributions/draws taken by owners/principals unless they exceed the Equity Value of their investment(Retained Earnings + Capital Given to Co.).  If they exceed the amount of the Equity Value then they are subject to paying Capital Gains up to a whopping 35%, shown on K-1 and placed on Schedule D(part of 1040).

No 1099's are distributed, nothing......however this will change(2011-2012) with Obama in office as part of the healthcare reform and tax adjustments, draws will soon be taxed(1099-MISC) and you will pay self-employment taxes on those draws upwards of 30%, double the current rate.