Taking Money Out of a Partnership
There are three common ways to take money out of a partnership:
- Distributions of income
- Loans to partners
- Returns of capital
Distributions of Income
There are a few allocation methods used to distribute partnership net income:
- Relative capital investments of the partners.
- Specified ratios.
- Service contributions of the partners.
You can even use a combination of the above allocation methods.
The most common method used to allocate partnership net income is the relative capital investment of each partner. For example, partnership A and B each contribute 50% of the capital. Each partner will receive 50% of net income.
The partnership agreement may stipulate that an unequal percentage of profits is to be distributed to a partner regardless of the amount of his capital contribution.
For example, partner A and B each make capital investments of 50% each and agree to pay 40% of net income to partner A and 60% to partner B.
S corporation shareholders are not permitted to make distributions that are disproportionate to their relative investments. Distributions to S corporation shareholders must be made in accordance with each shareholder's percentage of stock ownership (if you own 30% of the stock, you get 30% of the profits and losses).
Loans to Partners
Partners may borrow from the partnership. A Notes Receivable account should be set up to record loans to partners from the partnership. A promissory note should be prepared and signed by the partner. The note should contain the terms of the loan.
For example, the amount to be financed (the principal), interest rate, repayment date(s), installment payment amounts, late payment penalties, etc.
Returns of Capital
You can take money out of a partnership by getting back part or all of your capital investment. A return of your capital is not taxable.
However, if you liquidate the partnership and receive more than your capital investment, the excess is a capital gain. If you receive less than your investment, you have a capita loss.
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- Return to the Tax Basics for Startups Table of Contents to find related links.