Distributive share refers to the allocation of income, loss, deduction, or credit from a business to a partner in a partnership or an S Corporation owner. The distributive share is based on the net income of the business, as calculated on the business partnership return (Form 1065) or S corporation return (Form 1120-S).
Since a limited liability company (LLC) with more than one member files a partnership tax return, distributive share also applies to LLC members. Distributive share is also applied to S corporation owners, based on their percentage share of shares owned in the S corporation.
How Distributive Share Is Determined
The allocation of distributive share is usually determined by the partnership agreement, which includes the allocation of the total net income for the year for all partners, totaling 100%.
If there is no partnership agreement, each partner's distributive share is based on their ownership of the partnership, calculated from capital contributions, interests in the economic or taxable income of the partnership, and rights of partners to partnership assets if the partnership is liquidated (sold or in bankruptcy). No withholding is taken from a partner's distributive share, so the entire amount is subject to tax along with other income on the partner's personal tax return.
Distributive Share and the Owner's Tax Statement
Schedule K-1 is the document used to show the distributive share of a partner in a partnership, a member of an LLC, or an owner of an S Corporation. A Schedule K-1 is not used for a sole proprietor or an LLC with only one member, because in these cases the entire net income of the business, as calculated using Schedule C, goes to the sole owner.
For example, if there are three partners in a partnership, one might have a 30% share, another a 50% share, and the third a 20% share. Income would then be distributed among the partners based on their share.
Taxing Distributive Shares
The process for determining the distributive share of a partner works like this:
- The partnership tax return is prepared, on Form 1065, as of the end of the partnership's fiscal (financial and tax) year.
- Then the total net income (profit) for the partnership is divided among the partners, according to each partner's distributive share. Note that the partners are taxed on the net income of the partnership, even though an individual partner may or may not have received distributions from the partnership during the year.
- A Schedule K-1 is prepared for each partner, showing their distributive share for the year.
- The individual partner includes the income or loss shown from Schedule K-1 on their personal tax return for the year.
- The partnership tax return is filed as an information return, including copies of all the Schedule K-1 documents for all partners.
The individual partners must pay self-employment tax (Social Security and Medicare) based on their distributive share of the partnership, as shown on Schedule K-1, not on any amounts the partner received from the partnership during the year. S corporation shareholders do not pay self-employment tax, because they are shareholders, not owners.