You’ve likely heard of distributions related to your business, maybe in conversation with your accountant, among other business owners, or on your tax paperwork. Distributions are a core part of every business and key in determining small business owner salary, yet many business owners don’t know how to make distributions or how to use them.
Distributions are used to pay business owners their share of their business’s profits and earnings. You might be taking a distribution and not even realizing it, instead referring to it as your pay or salary.
Knowing the concept of distributions and how to make them can help you take as much financial reward from your business as is reasonably possible.
Here, we take a deeper dive on small business owner salary as well as distributions, how to make them, and how you should be using them.
Where can I find distributions on my financial statements?
Although paying yourself seems like it should be an expense that’s listed on your profit and loss statement, distributions are actually listed on your balance sheet. This is because distributions have no effect on your business’s profitability or the amount of taxes your business will pay.
Distributions are made to business owners by taking cash out of the business from retained profits or cash that investors put into the business. You’ll see it show up on a cash flow statement or a balance sheet, but not a profit and loss statement. When it’s time to prepare tax returns, distributions show up in two important places:
- For the business, distributions show up on the balance sheet section of your tax return (total distributions since the company started) and in Section M-1, which shows distributions that have been made through the year.
- For the business owners, distributions and dividends show up on the form K-1 that they receive from the business. This document is used to prepare personal taxes.
What’s the difference between a distribution and dividend and who can receive them?
Most small businesses are LLCs or S-Corps and aren’t likely to have dividends. Distributions are a payout of your business’s equity to you and other owners. That means they can come from the accumulated profits or from money that was previously invested in the business and are not factored into how much a business owner is taxed.
Dividends come exclusively from your business’s profits and count as taxable income for you and other owners. General corporations, unlike S-Corps and LLCs, pay corporate tax on their profits. Distributions that are paid out after that are considered “after-tax” and are taxable to the owners that receive them.
Any legitimate shareholder or LLC member is eligible to get distributions. Generally any time distributions are paid, everyone who is eligible to get them must get their share. That means in a four equal-partner business, in order for one partner to receive $1,000 in distributions the business must pay out $4,000 in total with $1,000 going to each of the four partners.
How much in distributions can my business pay?
Choosing how much to pay in distributions can be as complicated or as simple of a choice as you want. On the most basic level you can follow these rules:
- Pay less in distributions than your business made in profits in a period.
- If your business is not profitable, don’t pay any distributions.
- Even if you have profits to pay out, make sure to hold on to permanent working capital, or a cash reserve.
On a more advanced level, the way that your business pays out distributions might be set in your charter documents (bylaws or an operating agreement). Generally, the rules above still apply but charter documents get much more specific about:
- Exactly how to calculate your profits that are available to pay out in distributions
- How much to reserve for any corporate, state, or local taxes
- How much of a permanent working capital reserve your business needs
- How much to hold onto to build permanent working capital
- How often distributions are paid (usually quarterly or annually).
- Use of accelerated distributions, or distributions that are paid at a faster rate to some investors or owners as an incentive for them to be part of the business.
Ask your accountant for advice
Distributions are something that you should be aware of as a business owner and should know enough about to be able to pay out throughout the year, but it’s a subject that you shouldn’t go at alone. An accountant can help you determine the following:
- How much of the payments made out each year can be counted as distributions
- How to make sure each owner’s capital account is adequately maintained
- How to make other payments from your business, like salaries and guaranteed payments, that might be more effective for tax purposes.
If you need assistance, Pursuit can help
If your business needs a working capital boost, talk to Pursuit. We offer more than 15 loan programs that can help your business keep moving forward.