What is tax basis?

Tax basis is the original cost of an asset for tax purposes, used to calculate gain or loss upon sale and determine depreciation deductions. For professional service firm owners, the tax basis in their business interest affects the taxation of distributions and eventual sale proceeds.

Key characteristics

• Original cost for tax purposes

• Used for gain or loss calculation

• Adjusted for contributions and distributions

• Affects depreciation deductions

• Different from book value

• Critical for exit planning

Why it matters for professional service firms

Tax basis determines how much of a sale or distribution is taxable. Low basis means more taxable gain. Professional service firm owners should track their basis in business interests and understand how contributions, profits, losses, and distributions affect it over time.

Real-world example

Jennifer started her LLC with a $50,000 contribution (initial basis). Over 5 years: allocated profits of $380,000, increased basis, distributions of $320,000, decreased basis, resulting in a current basis of $110,000. If she sold her interest for $400,000, the taxable gain would be $290,000 ($400,000 minus $110,000 basis). Basis tracking enabled accurate tax planning for a potential sale.