How Much Can I Take Out of My Business in Distributions?Posted on July 13th, 2021
Outsourced Accounting Department, Inc.
A client of ours who had been accumulating a lot of cash in their business account, recently asked me if they could start distributing some of that to themselves to put the money to better use. This client like many small businesses, files their business tax return as an 1120-S, “S-Corporation,” wherein their business profit is taxed on their personal tax return. For tax purposes there are several advantages to filing taxes this way (which is a topic for another article). But it certainly does create much confusion for many small business owners.
To clarify, in an S-Corporation, your profit is treated as income to you on your personal tax return, regardless of whether you actually “distribute” cash to yourselves. So your profit (or more accurately your taxable income), generally is the maximum you would want to distribute to yourself without the risk of increasing your tax liability. Typically, we show the actual cash payments clients make to themselves during the year as “loans” from the company to the owner (i.e., “Due From Shareholder” asset account in the case of a corporation, or “Due From Member” account in the case of an LLC). Then at the end of the year, we reclassify these as “distributions” based on the company’s year-end profit.
Some businesses which maintain large amounts of inventory and sell on credit terms, cannot afford to distribute their profit to the owners because it’s needed to finance sales growth (i.e., increased accounts receivable and inventory), pay back business loans, etc. In other cases, some companies can obtain customer deposits up front to pay material costs, so they are essentially “cash-basis” businesses, and such cash requirements are not as much of a concern. Again, there can be a difference between “business profit,” which you look at to evaluate the performance of your business, and what is considered “taxable income” to the IRS. Care must be taken not to exceed your what’s called your “shareholder basis,” so if you aren’t sure, ask your CPA or other tax preparer for assistance.
Now, as to this particular client, they have been taking cash distributions all along, but which were not tied directly to the company’s profit. So a large portion of cash that was accumulating in their business account was basically their own money upon they have already paid taxes through their personal tax return. And, it was not all needed by the business to fund operations, as this business receives customer deposits up front (as described above). So I did some calculations to determine how much their historical cash distributions have totaled, versus their accumulated profit to date (Retained Earnings). The result was a substantial dollar amount they were further entitled to take out as distributions.
More simply stated, the undistributed Retained Earnings balance in the “Stockholder’s (or Member’s) Equity” on your balance sheet is a good place to start looking to see if there is more money you can safely distribute to yourself. If your accountant adjusts out your cash distributions at the end of each year out of Retained Earnings (which we do), then the Retained Earnings balance itself is the number you are looking for. Otherwise, if you see a negative balance in the Shareholder Distributions account, you must first subtract that number from whatever is showing in Retained Earnings. (Again, check with your CPA or tax accountant first, as Shareholder Basis for tax purposes is a bit tricky.)
Then going forward, to determine how much you can distribute to yourself during the course of the year, keep an eye on your monthly Net Income (and CASH FLOW!)