Distributions and taxation - Part 2
A previous version of this article had some inaccurate statements, and has been withdrawn. The following is the corrected version.
This is the second in a series of articles about Distributions and Taxation of Partnerships.

In the first article of this series, I made the following statement:

Distributions made to partners, whether in total or partial liquidation of the partnership interest, are not taxable to the partners unless cash distributed is in excess of the partner's basis in the partnership.

This has prompted several questions, which I would like to discuss in some detail.

Rip, let's explore this for the sake of my own understanding, please.

Suppose a member with a basis in the partnership of $10,000 requests a distribution of $5,000. Are you saying that the member pays NO TAX?
Yes, that is exactly what I am saying. The member's basis will be reduced to $5,000, and he/she can receive $5,000 more before there is any taxable consequences.

Suppose we decide to give them $2500 cash and $2500 in stock. Is there any tax due
No, there is still no tax due. But let's explore the $2500  in stock. If the $2500 represents the basis of the stock in the hands of the partnership, then the member's basis in the partnership becomes $5000 (10000-2500-2500), and his/her basis in the stock is the same as the partnership's - $2500. Note that this would be true even if the value of the stock distributed were $20,000. Yes the member can receive cash of $2500 and stock worth $20000, and pay no immediate tax. Of course, when the stock is sold, the gain that will be reported will be the difference between the proceeds realized and $2,500.
In a partial withdrawal, the member's basis in the partnership is reduced by the total of cash received
and basis of the stock transferred.
Suppose the same member requests a distribution of $15,000, and we give them cash. Their basis is still $10,000. By your statement, I assume the member pays tax only on the difference of $5,000. Correct?
Correct. The member's cash distributions have exceeded his/her basis by $5,000, and tax will have to be paid on that excess.

Suppose we distribute $12,500 cash and $2500 in stock. What is taxed?
In this case, we reduce the basis by the amount of cash received plus the basis of stock transferred, but we can't reduce the basis below zero. Therefore, the cash has exceeded basis by $2,500, which is taxable, and the stock has no basis in the hands of the member. In other words, when the member sells the stock, all the proceeds will be taxable.

It is important to remember that distributions are never taxed at the partnership level. If a member receives cash in excess of his/her basis, such excess will be declared as taxable income on the partner's individual return.

In the next article, we will explore how that excess is reported on the individual return.

Rip West
Ridgway, CO