Need a little help on my first 1065

[Janitor Bob]

couple forms LLC in 2014...buys cheap/scrap electronics.  Buys parts and repairs the electronics, then sells them for a profit.  $11,000 sales with $6,000 total expenses.  I see cash withdrawals of $3,000 from their checking account (not used for business expenses).  Should I treat the $3,000 as salary or guaranteed payments to partners?

 

Forgive my ignorance, but after more than 20 years doing taxes, this is my first 1065....I'm used to Sch C

[Margaret CPA in OH]

Well, partners don't receive salaries. See the operating agreement as to guaranteed payments, likely they don't have them. More likely these are just distributions from the capital accounts.

[rfassett]

Not guaranteed payment unless the partnership (LLC operating) agreement says so.  Not salary unless the LLC is set up to do payroll.  It would be a draw just like you would have a draw on your Schedule C clients.  The bottom line of the 1065 goes to the K-1 which goes to the members individual 1040s.  My guess is it, the K-1 amount is also self employment income.  Are you certain that the multi-member LLC has not elected to be taxed as a different entity, say 1120S?  Just asking to cover all bases.

[rfassett]

Another point, most likely not required on your 1065, but I ALWAYS do the balance sheet even if not required.  Keeps things cleaner from year to year.

[Jack from Ohio]

Well, partners don't receive salaries. See the operating agreement as to guaranteed payments, likely they don't have them. More likely these are just distributions from the capital accounts.

Agree with Margaret.

[Janitor Bob]

Thanks to all of you...Good Points

[BulldogTom]

JB,

 

On a simple 1065, don't overthink it.  You still have the same revenues, cost of sales, and expenses to get to net profit.  The 1065 just asks a lot more questions about the partners and their business.  Then it gets different when you have to put in the balance sheet (do it even if not required) and the partnership percentages to get  the K-1's to spit out.  ATX is not real friendly in that area, but once you go through it, it is not bad.   Take your time and ask questions here about where to find things in the software.

 

From what you posted, this is a nice introduction to the 1065 and well within your ability.

 

Tom

Newark, CA

[Terry D EA]

I agree with Margaret as well.

[DANRVAN]

I disagree. Section 707(C ) states that "payments to a partner for services are guaranteed payments" without any reference to a partnership agreement.  In fact, there are cases where the IRS  and the courts have reclassified  capital distributions as guaranteed payments. For example see  SEISMIC SUPPORT SERVICES, LLC, SCOTT A. WHITTINGTON TAX MATTERS PARTNER v COM. where they looked at substance over form.

 

In regards to the JB's question I believe the correct answer is it depends on the facts and circumstances. Did all partners contribute and withdraw equally?  Did they  intend for one partner to perform most of the work while another put up most of the capital?

Edited January 26, 2015 by kcjenkins

[rfassett]

Actually, this is what 707(c ) states:

 

(c ) Guaranteed payments  To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses).

 

I will concede that it does not HAVE to be in the partnership agreement. But I will also state that I have NEVER seen a partner paid without regard to the income of the partnership where such arrangement was not stated in the partnership agreement.  I do a fair amount of partnership work so this is not just an off the cuff remark.  If the guy gets a draw because the partnership had income and did not get one when the partnership had no income, it is prima facet evidence that the payment was tied to the partnership generating income and not some sort of guaranteed payment.  Likewise, if the partner receives a check, regardless of the partnership generating income (with funds say coming from an LOC or another partner contribution) then this would be prima facet evidence of guaranteed payments.  In the present case, although it is not stated, I was simply encouraging the OP to look to the partnership agreement for a clue as to the treatment of those payments.

[DANRVAN]

 

I was simply encouraging the OP to look to the partnership agreement for a clue as to the treatment of those payments.

And most likely there was not an agreement. In any case, I believe it is important to educate the client in the difference between "draws" and GP's. In particular the effect on SE income. 

 

In the case where one partner performs more work and receives more $, fair allocation of SE income can be achieved through GPs.  This is common in farming operations where son/partner performs most of the work while dad/partner provides capital.  The fact that payments to the partner are not consistent or vary with cash flow does not preclude them from being classified as GP.

 

The bottom line is to work with the clients to determine what works best for them within the tax laws.

[DANRVAN]

KC, thanks for the edit help. How did you do that?

[rfassett]

And most likely there was not an agreement.

 

That is a pretty big stretch.  All of my partnership clients operate with an agreement.  All of them.  I will not have a partnership client without one.

[rfassett]

And the allocation of income in a partnership has nothing to do with GP.  If the concern is allocating SE income to a capital only contributor then I would say that a Limited Partnership would be a better fit.  I have the exact scenario you describe for your farmer client several times over and they are all LPs.

[jklcpa]

KC, thanks for the edit help. How did you do that?

 

If the edit was because your "(c )" turned into a copyright symbol, it's because it needs a space after the letter 'c' and before the closing parenthesis to display properly on this forum. The same thing happens with 'b' and without the space, it turns into .

[DANRVAN]

In this case being a general partner is better considering the overall tax picture for dad. The guaranteed payment to son is SE income to son and reduces the amount of income that could be allocated as SE to dad. 

[kcjenkins]

KC, thanks for the edit help. How dpmid you do that?

You are welcome, and I sent you the explanation as a PM at the same time.  Look at the top of the page to see the little red note on the message icon.  

[Janitor Bob]

These two clients have no idea what they are doing or what they want to do...certainly no GP agreement.  Basically, they wanted to start a business and a friend told them they should form an LLC so they did.  They have no idea how to keep books/records other than the most basic sales/COGS.  The only reason their records are as clear as they are is that almost everything was done on-line through e-bay...which kept track of their sales, returns, fees, and withdrawals from their capital account for them.  I am just trying to work with them to find out what they spent on purchases (COGS) and other expenses. My original question about the withdrawal was because I saw a $3,000 withdrawal from their e-bay cash account that was not related to any e-bay fees/expenses....just cash out of their account into partner's pocket.

 

I now need to find out if that $3,000 was used to purchase more items for re-sale (COGS) or just for personal use.

 

one partner (who initiated the withdrawal and is really the most active partner) contributed all of the capital to start the business.  He is 75% and girlfriend is 25% in the partnership.

[mcb39]

It sounds like a withdrawal from his Capital Account; which will not affect the bottom line as long as he didn't withdraw more than he put in originally.  I doubt that he used the money to purchase more stock.  If he is a 75% owner, it would not be a GP; but just a withdrawal.  With Partnerships, you have to remember that Capital Accounts and the bottom line (Profit or Loss) are two totally separate things.  The bottom line is what determines the Partners' income or loss.  (I, just this morning) transferred $5000 from our personal funds into my husband's Partnership to cover checks that are being written this week.  That will increase his Capital Account and have nothing to do with the P/L of the business.  When, or if, he withdraws it; it will reduce his CA.  (Or, if the Partnership has a loss on the bottom line; that will also decrease his CA)

[Lion EA]

Does the partnership had a banking account?  Did they move funds from e-Bay into their partnership account?

 

You have a great training opportunity with a start-up partnership.  And, maybe a bookkeeping opportunity.

[Janitor Bob]

They have a banking account NOW for the LLC, but did not have one last year.  However, their "cash" account on e-bay may be the same thing.

[Lion EA]

Just trying to trace the money from ebay to...in hopes it was to the partnership's bank and not a partner's pocket.  As long as they recorded what they did, you'll be able to report it.  Follow the money.

[kcjenkins]

They have a banking account NOW for the LLC, but did not have one last year.  However, their "cash" account on e-bay may be the same thing.

Yes, it is the equivalent of a bank account.  Thank goodness eBay keeps and provides those records.  

 

Worst client records I ever had was a woman whose 'business' was a flea market stall.  She actually made money at it,[i think   ]  and I think she was honest, but her 'records' were horrible, she bought almost everything with cash, sold for cash, did not really track inventory, etc.  She might have a note, "bought table $95 3/312/09" in her spiral-bound 'bought' notebook and then in her her 'Sales' spiral-bound notebook on 4/4/09 she had an entry 'table $165".  Was it the same table?  No idea.  And that was an easy one.  Many of those purchases and sales were just noted as "kitchen tools", "art", "dishes", "books".  I gave up on any idea of tracing items for COGS.  I just assumed no inventory carryover, for tax purposes.  All sales counted, all purchases as COGS.  If I had not thought she was honest, I'd never have done her return.  But she had no kids, was not trying for EITC, she could have easily flown under the radar of the IRS.  She just wanted to do things right, so she filed on it every year and paid taxes on her small profits.

[Janitor Bob]

Your client sounds EXACTLY like my couple.  Hopefully, I can train them on proper bookkeeping since they just started and seem eager to do it right.