Q: Should the Section 179 Deduction be adjusted back into personal income if it’s reported on the personal tax return since it’s not a true cash expense?
A: For a Subchapter S corporation., Partnership, or LLC where the tax obligation passes through to the owner(s), the Section 179 Deduction is also passed to the owner(s) of the business. The Section 179 Deduction does not reduce the individual’s personal cash flow. It only reduces taxable income of the individual. For a Subchapter S corporation., Partnership, or LLC, the Section 179 Deduction passes through to the owner on the Schedule K-1, then flows to the Schedule E where it is used to offset any Ordinary (Taxable) Business Income that is passed to the owner from that business entity for tax purposes.
Recall that Ordinary (Taxable) Business Income that flows from the business via the Schedule K-1 to the owner’s Form 1040 taxable income is all non-cash. It is not included in the individual’s cash flow calculation. The Section 179 Deduction is also non-cash, and it does not impact the cash flow calculation for the individual because it is only used to reduce the Ordinary (Taxable) Business Income that is passed through to the owner. Neither of these numbers would be included in the personal income cash flow calculation for an owner in any way.
When you are completing a business cash flow calculation, it is GAAP depreciation amount that needs to be added back, along with any GAAP amortization, as those are included in expenses in the calculation of Net Income for the business. The Section 179 Deduction is not recognized under GAAP. Therefore, unlike depreciation and amortization, it is a) never used in the calculation of accrual Net Income and b) never added back to Net Income in computing traditional cash flow. In effect, the Section 179 Deduction has no impact on cash flow for the business or for the owner.
Q: What is a distribution with a built-in gain?
A: This is a property contributed to a partnership that has a built-in gain. This property would be reported on the tax return at the time the property is distributed to an owner. The partner contributing the property may be liable for tax on the built-in gain.
Course overview: Understanding Schedules K-1