Taking cash out of your LLC usually doesn’t create a separate tax bill. Under the default pass-through rules, tax on an LLC distribution is really tax you already owe on your share of the LLC’s profits, which you pay whether or not any money is actually distributed. The distribution itself becomes taxable only when the cash you receive is greater than your adjusted basis in the LLC, and the excess is treated as a capital gain.
Why the Distribution Itself Usually Isn’t the Taxable Event
The IRS doesn’t tax a default LLC as a separate entity. Profits and losses flow through to each member’s personal return, so you owe income tax on your allocated share of the year’s net income even if the LLC reinvests every dollar and pays out nothing. The tax bill follows the profit allocation, not the cash.
A multi-member LLC files Form 1065 as an informational return and issues each member a Schedule K-1 showing their share of income, losses, deductions, and credits.1Internal Revenue Service. 2025 Instructions for Form 1065 Those K-1 numbers go on your personal return. When cash later leaves the LLC and lands in your account, that transfer is just a return of capital or a payout of profits you’ve already been taxed on. It reduces your equity in the business and, in most cases, doesn’t generate any new tax.
A single-member LLC is treated as a disregarded entity, so income and expenses go straight onto your Form 1040 (Schedule C or Schedule E, depending on the activity), and money you move to yourself is an owner’s draw rather than a distribution in the partnership sense.2Internal Revenue Service. Single Member Limited Liability Companies The mechanics below apply to multi-member LLCs taxed as partnerships, which is where distribution taxation actually gets interesting.
Your Adjusted Basis Decides Whether a Distribution Is Taxed
Basis is a running tally of your after-tax investment in the LLC. It starts with what you contributed when you joined and moves every year based on what happens inside the business.
Your basis goes up when you contribute more capital (cash or the fair market value of property), when the LLC allocates income to you, and when your share of LLC debt increases. Your share of LLC liabilities counts as an additional investment for basis purposes, which matters more than most members realize.3Office of the Law Revision Counsel. 26 USC 752 – Treatment of Certain Liabilities
Your basis goes down when you receive distributions, when the LLC allocates losses to you, and when your share of LLC debt drops. If the LLC pays down a loan or you leave the LLC, your basis falls even if no cash moved that day, which can set up an unexpected gain the next time you take money out.
When a Cash Distribution Actually Triggers Tax
As long as the cash you receive is at or below your adjusted basis, you owe no tax on the distribution. Your basis just drops, dollar for dollar.4Office of the Law Revision Counsel. 26 USC 731 – Extent of Recognition of Gain or Loss on Distribution A member with a $75,000 basis who receives a $50,000 distribution owes nothing extra, and their basis becomes $25,000.
The tax hits when cash exceeds basis. If that same member instead received $90,000, the first $75,000 would take basis to zero, and the remaining $15,000 would be a recognized capital gain in the year of the distribution. If the member had held their LLC interest for more than a year, the gain qualifies for long-term capital gains rates, which run lower than ordinary income rates for most taxpayers. Basis can never drop below zero, and that floor is what pushes the excess onto your return.
Property Instead of Cash
If the LLC distributes property rather than cash, the transfer is generally not taxable to either the member or the LLC. You take the property at the LLC’s adjusted basis in it (or your remaining outside basis, whichever is lower), and your basis in the LLC decreases by the same amount. The tax is deferred, not erased: when you eventually sell the property, the built-in appreciation from the LLC’s holding period comes through as gain. Special rules apply if the distributed property includes unrealized receivables or substantially appreciated inventory, which can convert what would have been capital gain into ordinary income.
Distributions Are Not Guaranteed Payments
A guaranteed payment is a fixed amount paid to a member for services or for the use of capital, owed regardless of whether the LLC made a profit that year. The tax code treats it like a payment to an outside contractor: the LLC deducts it as a business expense, and the member reports it as ordinary income subject to self-employment tax.5Office of the Law Revision Counsel. 26 USC 707 – Transactions Between Partner and Partnership No withholding happens, so the member covers the tax through quarterly estimates.
A distribution, by contrast, isn’t deducted by the LLC and isn’t reported as income on its own line because the underlying profits already flowed through the K-1. Misclassifying one as the other changes both the LLC’s deductions and the member’s self-employment tax exposure, and the IRS pursues both directions on audit.
Self-Employment Tax on the Underlying Income
Self-employment tax is the LLC member’s version of Social Security and Medicare. The combined rate is 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare.6Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) It applies to your allocated share of the LLC’s business income, not to the distribution. You can receive zero cash and still owe self-employment tax on the K-1 profit.
The Social Security portion applies only up to $184,500 of earnings in 2026.7Social Security Administration. Contribution and Benefit Base Above that, only the 2.9% Medicare tax applies, and higher earners pay an added 0.9% Medicare surtax on self-employment income above $200,000 (single) or $250,000 (married filing jointly).
Members who put up capital but don’t materially participate in the business are generally not subject to self-employment tax on their distributive share. Guaranteed payments for services stay subject to self-employment tax regardless of participation.
Net Investment Income Tax for Passive Members
If you’re a passive member, a 3.8% surtax may apply on top of regular income tax. The Net Investment Income Tax hits the lesser of your net investment income or the amount your modified adjusted gross income exceeds the threshold for your filing status.8Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax The thresholds are $200,000 for single or head of household filers, $250,000 for married filing jointly, and $125,000 for married filing separately. They aren’t indexed for inflation and haven’t moved since 2013.9Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
Members who actively participate in the LLC’s business aren’t subject to NIIT on that business income, though other investment income can still push them past the threshold.
If the LLC Elects Corporate Taxation
An LLC can file Form 8832 to change its federal tax classification, and the distribution analysis changes with it.
S-Corporation Election
With an S-corp election, the LLC is still a pass-through, but members who work in the business must draw a reasonable W-2 salary before taking distributions.10Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers The salary carries payroll tax withholding; distributions of remaining profits do not owe self-employment tax at all. The IRS looks closely at S-corps where the owner runs a low salary and takes most compensation as distributions, and can reclassify distributions as wages if the salary isn’t defensible.
C-Corporation Election
A C-corp election creates double taxation. The LLC pays corporate income tax on profits, and distributions come out as dividends taxable again on the member’s return. Qualified dividends get preferential rates of 0%, 15%, or 20% depending on the bracket, but the combined burden is usually higher than pass-through treatment for a small business. Dividends are paid from after-tax profits and don’t reduce the entity’s taxable income.
Liquidating Distributions Work a Little Differently
When a member exits the LLC entirely, the final payout is a liquidating distribution. The core rule is the same: gain is recognized to the extent cash exceeds outside basis. The difference is that a liquidating distribution can generate a recognizable loss, which an ordinary distribution never can.11Internal Revenue Service. Liquidating Distributions of a Partner’s Interest in a Partnership
If your entire interest is terminated and you receive only cash, unrealized receivables, and inventory, you can deduct a loss equal to your remaining basis minus what you received.4Office of the Law Revision Counsel. 26 USC 731 – Extent of Recognition of Gain or Loss on Distribution Receiving any other property (equipment, real estate) as part of the liquidation blocks loss recognition, even when that property is worth less than your basis. A liquidation paid as a series of payments defers gain recognition until cumulative cash exceeds starting basis.
Tax Distributions Built Into the Operating Agreement
Because members owe tax on allocated profits whether or not cash flows to them, many operating agreements require the LLC to make “tax distributions.” The formula typically takes each member’s share of net taxable income, multiplies it by an assumed rate (often the top individual marginal rate), and distributes at least that amount so no member has to pay tax on phantom income out of pocket.
Tax distributions are still ordinary distributions for basis purposes. They reduce your adjusted basis and follow every rule above, including the point at which cash above basis converts into a recognized capital gain. The label is contractual, not a separate tax category.