Q: Please confirm and clarify if needed. A distribution reported on a Schedule K-1 is never taxable to the partner, stockholder, or member whose taxpayer identification number (TIN) is on the Schedule K-1?
A: Confirmed. Distributions are not reported as taxable income on the receiving owner's or partner's personal income tax returns. To expand our answer, distributions are not reported as a tax-deductible expense on a pass-through company's information-only business income tax returns.
There is an exception. If cumulative distributions exceed an owner's or partner's "basis" in a company, the excess amount is taxed as a long-term capital gain. The definition of "basis" varies. For a Subchapter S corporation, “basis” is the owner's equity in the company plus loans from the owner to the company. For a partnership, “basis” is the partner's equity or net worth in the partnership plus his or her share of partnership debt obligations.
It rarely happens that distributions exceed "basis".
Q: If a loan to an owner of a “pass-through” entity is subsequently converted to a distribution, the loan / distribution cash flow to that owner or partner whose taxpayer identification number (TIN) is on the Schedule K-1 is never taxable?
A: Correct. Loan proceeds are never taxable. Distributions are never taxable to the recipient so long as those distributions do not exceed "basis". When that occurs, distributions are taxed as long-term capital gains.
Course overview: Covenant Use in Controlling Cash Outflows
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