This example shows why distributions are not income.
DISTRIBUTIONS ARE NOT INCOME
YOU ARE TAXED ON THE PROFITS OF THE COMPANY WHETHER YOU TAKE A DISTRIBUION OR NOT.
Example 1:
Let’s say you alone start a new company and you put in $10k.
The first year the company makes a profit of $100k. That makes $110k cash in bank.
You pay down debt of $40k (some call iit phantom income). Now you have $70k in the bank.
You distributed $60k.
Distributions = $60k but your taxable income is $100k.
That’s why we really need the Profit & Loss, not just the distribution total.
Example 2:
We can also provide examples of distributions being greater than income.
In the above, let’s assume you took out no distributions in year 1.
Cash in bank = $70k. Taxable income is still $100k.
Year 2 you have income of $80k. Cash in bank = $150k.
You take $100k home.
Distributions = $100k. Taxable income is $80k.
If Distributions are zero, Taxable income is still $80k.
The above is true as long as the shareholder has basis. Once basis is exhausted, the distribution is considered a short term gain.