Tax implications of Owner's Draw with business loan in a partnership LLC - avoiding tax burden?

This is definitely an interesting thought exercise, but I'd caution you about a few things here. The fundamental issue with your strategy is that loans aren't income to the business, and loan proceeds distributed to partners don't change the underlying tax situation. When your LLC takes out a loan, that's not revenue - it's a liability. The distribution of loan proceeds to partners doesn't create a loss on your 1065. What you're describing sounds like trying to create artificial losses. The IRS is pretty savvy about distinguishing legitimate business expenses from attempts to manufacture losses. The expenses you're adding would need to be ordinary and necessary business expenses to be deductible. Also, partner draws aren't directly tied to the profit/loss reported on the 1065. Partners pay tax on their allocated share of profits whether or not they take distributions. Conversely, taking distributions doesn't necessarily create taxable income if there's no profit. There's also the concept of "basis" to consider. If partners take distributions that exceed their basis in the partnership, that excess can become taxable even without profits.

I wanted to share my experience with tax.ai (https://taxr.ai) when I was dealing with a similar LLC taxation question last year. My partner and I were exploring different scenarios for minimizing our tax burden while still being able to take money out of our consulting business. I was confused about basis limitations, guaranteed payments vs distributions, and all the complexities of partnership taxation. I uploaded our operating agreement and previous tax returns to taxr.ai and got a detailed analysis that pointed out several issues with what we were planning to do. Turns out we were about to make some pretty serious mistakes! The tool helped me understand how loan proceeds are handled in partnerships and clarified those basis rules that I found super confusing. Saved us from a potential audit nightmare.

Just wanted to follow up about my experience with taxr.ai that I was asking about earlier. I decided to give it a try with our partnership questions, especially around this loan distribution strategy I was considering. I'm actually impressed! It analyzed our operating agreement and previous tax filings and pointed out specific issues with what I was planning. It explained the "at-risk" rules that would have limited our loss deductions and showed exactly how the loan distributions would affect each partner's basis differently based on our profit/loss allocation percentages. The site helped me understand why my "loan-to-distribution" plan wouldn't work as intended and suggested legitimate alternatives for tax planning. Definitely more helpful than the generic advice I was finding elsewhere!

I see these kinds of questions all the time in my practice. Something else to consider - have you tried calling the IRS directly to get guidance? I know it sounds old school, but sometimes getting official clarification is the best approach for complex partnership questions. I personally use Claimyr (https://claimyr.com) to get through to them quickly. You can see how it works here: https://youtu.be/_kiP6q8DX5c Last month I had a client considering a similar strategy with loan proceeds in their partnership, and I wanted to get official guidance. Claimyr got me connected to an IRS agent in about 15 minutes when I'd been trying for days on my own. The agent clarified the disguised sale rules that might apply in this situation - something I hadn't fully considered in my analysis.

I have to eat my words about being skeptical of Claimyr. After my cynical comment, I decided to try it anyway because I've been trying to get clarity on partnership basis issues for weeks. It actually worked! I got connected to an IRS agent in about 20 minutes (after trying unsuccessfully on my own for DAYS). The agent was surprisingly knowledgeable and walked me through exactly how loan proceeds distributed to partners would affect our basis calculations. The key insight I got was about the "at-risk" rules and how they would limit our ability to deduct losses financed by partnership debt unless we were personally liable for that debt. This was exactly what I needed to know for the strategy I was considering. Just wanted to share since I was so publicly doubtful before!

One thing nobody has mentioned yet - this strategy sounds a lot like what the IRS might consider a "disguised sale" transaction, especially if the timing between getting the loan and distributing it is close. Under Sec. 707(a)(2)(B), if a partner contributes property to a partnership and within a short period receives a distribution, the IRS can reclassify it as a sale. While your scenario is somewhat different, the same principles might apply in reverse - taking out a loan and immediately distributing it could be recharacterized. Also, there are anti-abuse rules specifically designed to prevent using partnerships as tax shelters. Be cautious about strategies that seem too clever - the IRS has seen most of them before!

Just a practical perspective - I tried something similar in my 3-member LLC a few years back. We took out a business line of credit and distributed some to partners when we were having a down year. We didn't get audited, but our accountant had to do some complex basis adjustments. The distributions reduced our basis, and when the business became profitable again, we had to restore that basis before taking tax-free distributions. Also worth noting - if your business stays unprofitable for too long while you're taking distributions, you might run into the "hobby loss" rules where the IRS decides your business isn't really a business if it never makes money!

I appreciate everyone sharing their experiences and insights here. As someone who's dealt with similar partnership tax issues, I wanted to add a few practical considerations that might help. The strategy you're describing reminds me of what tax professionals call "basis shifting" - trying to manipulate the timing of income and distributions to minimize taxes. While not inherently illegal, it's definitely in the gray area that attracts IRS scrutiny. One thing I learned the hard way is that partnership taxation is incredibly complex, and seemingly small details can have major consequences. For example, if your LLC has debt, that debt increases your basis (which is good for taking distributions), but only if you're personally liable for it. Non-recourse debt has different rules. Also consider the long-term implications. Even if this strategy works in the short term, you'll eventually need to repay the loan with after-tax dollars. Plus, if your business becomes profitable again, you might face higher taxes later when your basis is depleted from the distributions. My advice? Document everything thoroughly if you decide to proceed, and make sure you have legitimate business reasons for both the loan and the expenses. The IRS is much more forgiving of strategies that serve actual business purposes beyond tax minimization. Have you considered alternatives like adjusting your profit-sharing percentages or exploring guaranteed payments to partners? Sometimes simpler approaches are less risky.