Legal Definitions - PTI

PTI stands for Previously Taxed Income.

Previously Taxed Income refers to earnings that have already been subject to income tax at one level and are subsequently distributed to another party without being taxed again. The primary purpose of this concept is to prevent the same income from being taxed multiple times as it moves through different entities or individuals. It ensures that once income has been accounted for and taxed, its subsequent distribution to owners or beneficiaries does not trigger an additional tax liability on that same amount.

Here are some examples to illustrate this concept:

• Example 1: S-Corporation Distribution

  Imagine a small software development company, "CodeCrafters Inc.," which is structured as an S-corporation. In this type of business, the company's profits are not taxed at the corporate level; instead, they "pass through" directly to the owners' personal income. Let's say CodeCrafters Inc. earns $200,000 in profit for the year. Its sole owner, Maria, reports this entire $200,000 on her personal income tax return and pays all applicable taxes on it.

  Later in the year, CodeCrafters Inc. distributes $100,000 of that profit directly to Maria's personal bank account.

  This $100,000 distribution is considered Previously Taxed Income. Maria does not pay tax again on this amount because she already paid income tax on the full $200,000 profit when the S-corporation earned it and it was reported on her personal return. The distribution is simply a transfer of funds that have already been accounted for tax purposes.

• Example 2: Partnership Payout

  Consider a marketing agency, "Creative Campaigns LLP," which operates as a partnership. The partnership itself does not pay income tax; instead, each partner reports their share of the partnership's profits on their individual tax returns. For a given year, Creative Campaigns LLP generates $600,000 in profit. Partner John's share is $300,000, which he includes on his personal tax return and pays taxes on.

  During the year, the partnership makes a cash distribution of $250,000 to John.

  This $250,000 distribution is Previously Taxed Income. John has already paid tax on his $300,000 share of the partnership's profits. Therefore, when he receives a portion of that profit as a distribution, he is not subject to additional income tax on that $250,000, as it represents income that has already been taxed at his individual level.

• Example 3: Trust Distribution of Retained Income

  Imagine a family trust, established to manage investments for beneficiaries. In Year 1, the trust earns $50,000 in investment income. The trustee decides to retain $20,000 of this income within the trust and pays income tax on that retained amount at the trust's tax rate. The remaining $30,000 is distributed to the beneficiary in Year 1 and is taxed to the beneficiary.

  In Year 2, the trustee decides to distribute the $20,000 that was retained and taxed in Year 1 to the beneficiary.

  This $20,000 distribution in Year 2 is considered Previously Taxed Income. Since the trust already paid income tax on this specific $20,000 in Year 1, the beneficiary does not have to pay tax on it again when they receive it in Year 2. The income was taxed once (at the trust level) and is now being distributed without triggering a second tax event.