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This is an excerpt from a presentation I give to college students and to prospective entrepreneurs about types of business entities.

A college professor (who’s also an attorney) told me that my presentation on this subject is the best, clearest and most-concise overview of the topic that she’s ever seen.

I’m flattered by the compliment, and will try to translate those positives into a series of blog posts.

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What is basis? I’ll attempt to answer that question in this post.

First of all, for the tax pros out there who read this blog and the other tax nerds who read this blog: this is a very basic and simplified overview of basis.

The Way I Explain Basis

At its simplest, basis is how much money and property you’ve put into the business, plus or minus the yearly profit or loss from the business, minus what you take out of the business,.

Example:

You and John are 50/50 owners of a partnership that you started this year. You put in \$10,000 of cash at startup. John put in \$10,000 worth of equipment. During the year, the partnership turned a profit of \$30,000. You withdrew \$5,000 while John withdrew \$0.

Here’s how your and John’s basis is calculated:

You

• \$10,000 initial investment
• Plus \$15,000 (your 50% share of the partnership’s profits)
• Minus \$5,000 of withdrawals
• EQUALS: \$20,000 ending basis

John

• \$10,000 initial investment
• Plus \$15,000 share of partnership profits
• EQUALS: \$25,000 ending basis

Why is Basis Important?

Basis is important for two reasons:

1. If you sell your partnership interest, your gain or loss from the sale will depend on your basis
2. In Part 3 I mentioned that withdrawals from a partnership are tax-free. That’s true … if you have enough basis to cover the withdrawal.

The term basis may come up again in our discussion of business entities. We haven’t gotten to S-corporations and C-corporations yet, but here’s how this discussion applies to them:

• S-corp: the basis calculation is basically the same as shown in this post
• C-corp: basis will almost always be what the shareholder originally paid for the stock, plus any additional money paid in. Withdrawals will probably be called a dividend (or a salary) and wouldn’t affect basis.