Negative basis in LLC

An LLC has two partners. Based on the information provided, the amount of distribution that one of the partners received from the LLC in 2018 would bring his capital account balance to negative.

I understand distribution in excess of capital account balance would be considered taxable capital gain to the partner in the year of distribution. I am just wondering if I, as the preparer of the LLC tax return, am supposed to report it that way knowing that the capital account of that partner would not be enough to cover the amount of the distribution? Is there any legitimate reason that the distribution to a partner can exceed his capital account balance?

A distribution in excess of BASIS is a taxable event. The tax capital account does not necessarily reflect basis. You need to consider any debt allocated to the partner as part of basis.

Thank you.

Yes, I should have said 'basis' instead of capital account balance.

What possible situations can cause a distribution in excess of the basis of a partner?

Accelerated depreciation causing a loss in the partnership and partner distributes a bunch of cash in the same year.

Even if the LLC took a large deprecation deduction on an asset, that in and of itself shouldn't result in a draw in excess of basis issue.

Is there any debt in the LLC? Is your client liable for any of that debt?

A common event that can cause a draw in excess of the member's basis is debt-financed draws, for which no LLC member is liable for. LLC borrows funds, no LLC member guarantees the debt, and LLC cuts draw checks from those funds to the LLC member. That is an example of a draw in excess of basis. But nothing operates in a vacuum-like that.


Do you track this members tax basis in the LLC? That running schedule will zero right in on whether you have draws in excess of basis.

I just want to clarify some terms to make sure my understanding is correct.

If the LLC borrowed money that no member was liable for - that would be non-recourse debt, non-recourse debt provides for tax basis 704(d) basis, but not for At risk basis - 465 basis. If the cash from that debt was then distributed to the partner(s) it would not be a distribution in excess of basis or taxable.

A distribution in excess of basis occurs when, for example a partnership (with 0 beginning basis) makes $40,000 - allocated $20,000 to each partner and then one partner receives a distribution of $30,000.

Thank you.

Yes, I should have said 'basis' instead of capital account balance.

What possible situations can cause a distribution in excess of the basis of a partner?

Generally, this would be caused by unequal capital contributions or unequal distributions.

One common issue I see were service partners are awarded loss and equity percentages, when they should have been awarded only profits, or the taxable income from an equity grant was overlooked.

For example - a partnership with a service partner and a money partner agree to split profits 50/50. The money partner contributes $100,000 and the partnership makes $40,000 profit. The partners then decide to distribute $35,000 to each partner (half of the funds in the bank) The service partner would have a distribution in excess of basis $35k > $20k his allocated profits.

One common issue I see were service partners are awarded loss and equity percentages, when they should have been awarded only profits

What would cause a partner to be allocated a profits percentage but not a loss percentage? Even if they didn't contribute any capital up front, shouldn't they be able to recognize losses against profits that arose in prior years?

What would cause a partner to be allocated a profits percentage but not a loss percentage?

The issue comes up when losses are allocated before profits to a profits-only partner. They don't actually have any basis to receive an allocation of losses because they have no economic investment in the entity.

After profits have been allocated and a capital account has been built up (IF), these partners would have an economic basis to receive a loss allocation. In my experience, though, usually these folks receive cash equal to their profit allocation, which precludes a capital account build up.