A question asked of me from clients who are new to being self-employed is “Are distributions from my business taxable?”
Usually the answer is “no”. Distributions (or draws) from a sole proprietor business, partnership, limited liability company (LLC), or s-corporation are usually nontaxable events. When a distribution is paid to an owner of a business, it reduces the owner’s capital account and basis in the business.
However, it is worth mentioning that distributions can become taxable if an owner takes distributions in excess of his or her basis in the business (except for sole proprietors and single member LLCs). The portion of the distribution that exceeds the owner’s basis becomes taxable.
The next question I usually get is, “Okay, if my distributions are not taxable, then what is taxable?”
Simply stated, business owners are taxed on their portion of the net profits of the business. So, whether or not the cash remains in the business checking account or has been distributed to the owners is irrelevant.
In addition to paying taxes on their portion of the net profits, owners of partnerships (partners) and multi-member LLCs (members) will also pay tax on any guaranteed payments received, while owners of s-corporations (shareholders) will also pay tax on any wages received.