The practice had its best year in a decade. The bank balance looks healthy, the accountant’s summary shows net income well ahead of last year, and the December check is smaller than the one that arrived 12 months ago. Every one of those statements is true at the same time. The partner holding the check has no way to reconcile them, because nothing in the agreement explains what the check was computed from, what the practice kept before anyone was paid, or why the money that showed up on the income statement never showed up in her account.
Distribution rules are where a partnership agreement stops being theoretical. Governance provisions get read once at signing. The distribution provision gets read every quarter, by everyone, with a calculator. And in most agreements it says something close to nothing: profits shall be distributed at such times and in such amounts as the partners shall determine. That sentence does not resolve a single one of the three questions that decide what a partner actually takes home—how often money moves, what number it is computed from, and what the practice holds back before any of it is distributed.
Start with timing, because it is the easiest to fix and the most often skipped. Most healthy practices run a hybrid: a regular draw paid on the payroll calendar, an interim distribution after each quarter closes, and a true-up once the year’s books are final and the tax return is prepared. The mechanics only work if the agreement says what a draw is. A draw is an advance against earnings, not a salary and not income. Write that sentence down. The partner who has spent three years believing the draw is her pay will experience the annual true-up as a confiscation, and no amount of arithmetic delivered in December will persuade her otherwise.
The arithmetic itself is worth walking, because it explains the check nobody expects. Take a three-partner pot of $733,200—$650,000 of owner earnings with $83,200 of individually allocated personal expenses added back—divided one quarter evenly at $61,100 a partner and three quarters by charge weight. Computed earnings land at $262,139, $244,400, and $226,661. Then the year’s draws and each partner’s own personal expenses come off as the advances they always were, and the December checks land at $58,539, $9,000, and $77,461. The $9,000 check belongs to the partner in the middle of the earnings range, and it is the method functioning rather than failing: his draw and his consumption simply arrived closer to his earnings during the year. That is exactly why the full table travels with every December check. A partner who sees only the check sees a punishment. A partner who sees the table sees a subtraction he already spent.
Decide in advance what happens when the number comes out negative, because it eventually will. The three defensible answers are a check back to the practice, an offset across a stated number of future quarters, or conversion to a documented partner loan at a stated rate. The indefensible answer is the fourth one—carrying the deficit silently on the books, where it compounds into a receivable from a colleague that nobody has ever discussed out loud.
Next, the basis. Cash-basis reporting recognizes revenue when it is collected and expense when it is paid, which is how the practice’s checkbook behaves. Accrual reporting recognizes revenue when it is earned and expense when it is incurred, which means a practice can report net income sitting in accounts receivable that no one can spend. Distribute against an accrual number and the practice has distributed money it does not have. Distribute against a cash number in a year that ended with a large payables balance and the practice has distributed money it already owes. Neither basis is wrong; silence is. The agreement names the basis, names which set of statements governs—the internally prepared package, the accountant-prepared statements, or a stated adjusted figure—and leaves the choice itself to the practice’s certified public accountant, who is the one person in the conversation qualified to weigh it against the tax return.
Then the safeguard, which is the provision that keeps a good year from becoming a cash crisis. Distributions are limited to the lesser of net income or available cash after reserves. Both halves earn their place. The net income limit prevents the practice from distributing borrowed money and calling it profit. The available cash limit prevents the practice from distributing a number that exists only on paper. The reserve floor is the operational half: a stated minimum—45 days of operating expenses is the dataset’s own formulation—held before a distribution dollar moves. That floor is a stop, not a goal. A practice’s actual reserve target should run higher, two to three months of operating expenses plus a tested line of credit, because a practice holding that much calls no one for money when a payer’s system goes down for six weeks.
Two reserves deserve their own sentences. The payroll reserve exists because payroll is the largest obligation the practice carries and the least postponable one; a distribution that leaves the practice unable to fund two pay cycles has converted an owner benefit into an employee risk. The tax reserve exists because of phantom income. In a pass-through entity, each partner is allocated a share of taxable income on a Schedule K-1 whether or not any cash was distributed, which means a partner can owe tax in April on money the practice retained in the prior year to buy an ultrasound. The fix is a tax distribution provision: a stated percentage of allocated taxable income, distributed ahead of the quarterly estimated-payment dates, treated as an advance against later distributions and reconciled at year-end. The rate belongs to the practice’s accountant. Article 16 takes the tax mechanics further.
Last, the approval process. Every distribution cycle should have an author, a computation, and a record: who proposes the amount, against which statements, at which meeting, and where the vote is minuted. That sounds bureaucratic until the first time a partner asks why the third-quarter distribution was $40,000 lighter than the second, and the answer is a line in the minutes rather than four different memories.
Red flags. Distributions made ad hoc, sized to whoever asked most recently or most loudly. No reserve requirement, so the practice’s cash position is whatever is left after the partners are finished. A tax reserve nobody defined, and partners meeting their K-1 income for the first time in April. An accounting basis that has never been stated, so the year-end conversation becomes an argument about which set of books is real. And a distribution history with no approval trail at all, which is the condition under which every past distribution becomes arguable at once.
The most expensive sentence in a partnership dispute is rarely about fraud. It is a partner saying she thought the money was going to be distributed—and being right, because nothing anywhere said otherwise.
| Partner | Computed earnings | December check |
|---|---|---|
| Partner 1 | $262,139 | $58,539 |
| Partner 2 | $244,400 | $9,000 |
| Partner 3 | $226,661 | $77,461 |
Most healthy practices run a hybrid schedule: a regular draw on the payroll calendar, an interim distribution after each quarter closes, and a true-up once the year’s books are final and the tax return is prepared. The mechanics work only where the agreement states that a draw is an advance against earnings rather than salary or income.
Three defensible answers exist: a check back to the practice, an offset across a stated number of future quarters, or conversion to a documented partner loan at a stated rate. The indefensible answer is the fourth—carrying the deficit silently on the books, where it compounds into a receivable from a colleague nobody has discussed out loud.
In a pass-through entity, each partner is allocated a share of taxable income on a Schedule K-1 whether or not cash was distributed, so a partner can owe tax in April on money the practice retained. A tax distribution provision fixes it: a stated percentage of allocated taxable income, paid ahead of quarterly estimated-payment dates and reconciled at year-end.
The Partnership Agreement Analyzer scores an existing agreement against the framework this series is built on — or schedule a discovery call to work through it with PMI. The full framework, with the arithmetic, lives in the textbook Pediatric Practice Management: The Fundamentals.