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LLC CPA gives an example of Partnership Distributions | Form 1065

LLCs can elect how they’re taxed. In this post, the LLC chooses to be taxed as a Partnership and files Form 1065 with the IRS. The following example illustrates a common trap for LLC Members; the IRS treats a reduction in a Member’s share of LLC debt as a cash distribution.

The following example is not comprehensive. And the IRS devotes lots of tax code to Partnership distributions. You can’t rely on this post as a reasonable basis for tax planning or Form 1065 preparation.

Let’s assume Member Mark holds a 25% interest in NC CPA, LLC, and has a tax basis of $25,000. The LLC distributes $25,000 to Mark in a non-liquidating distribution. After the distribution, Mark maintains a 15% interest in the LLC. Most folks would correctly figure that Mark has no tax consequences based on this simple fact pattern.

But NC CPA, LLC has $200,000 of debt. Before the non-liquidating distribution, Mark’s share of that liability is $50,000 (25% x $200,000). But afterwards, Mark’s share of the debt is $30,000 (15% x $200,000) . The IRS considers this $20,000 decrease in debt as a cash distribution to Mark. So, while the $25,000 of cash had no immediate tax consequences to Mark, the extra $20,000 of reduced liability is considered a Capital Gain.

I’m a LLC CPA with a virtual office to serve clients beyond my Wilmington NC geographical base. If your LLC doesn’t already have a CPA, or you like what you read, consider calling (910) 399-2705 for a free phone consult.


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