QBI and Guaranteed Payments

[Edsel]

A 95% partner is paid basic living expenses by the partnership, and they charge guaranteed payments.

Instead of this, what about considering a distribution, even if the 5% partner receives a prorated distribution as well.

The effect:  $0 guaranteed payments, and a higher partnership income subject to QBI.

Good strategy???

 

[Lion EA]

And, a higher partnership income subject to the partners' personal income tax rates. You'll have to run the numbers to see if there's a sweet spot. If both partners don't benefit under your plan, then how does the 5% partner's unhappiness upset the partnership or the other partner?

[Pacun]

I have a similar situation:

An employer sold company to employee but the selling partner will always get 25% of what is left after a guaranteed payment of $150K to the new 75% owner. for the past couple of years, the company has had a loss of about 5K.  I told my client (new 75% owner) to take less money as guaranteed payment to benefit from QBI but he didn't agree. He said that he deserves that amount of money because he works a lot of hours and he will have to share the left over with the silent "partner".

[jklcpa]

While I agree that there is a tax benefit if a payment to the partner can be properly labeled as a withdrawal vs guaranteed payment , the partnership and partners still need to follow tax law of what constitutes a guaranteed payment, follow the partnership agreement, and be able to justify that the payment(s) is a withdrawal and not a guaranteed payment, especially if payments were historically paid on a similar pattern or frequency and reported as guaranteed payments in the past.

You might consider reading this article that talks about what guaranteed payments are, and it may help you discuss this issue with your client:

https://www.cpajournal.com/2017/09/01/greatest-hits-avoiding-costly-mistakes-guaranteed-payments-partners/

[Edsel]

Thanks to all respondents.  Two features seem to eminate from Judy's article;

1. The IRS and courts have not reached any consistent application as to what constitutes a guaranteed payment.  This is typical, often the result of court decisions that go all over the map, and often the intention of the IRS to not be painted into a corner as a safe harbor that taxpayers can depend on.
2. Consistency in the taxpayer's history can establish a pattern for determining both guaranteed payments and capital distributions.

Many of us encounter flimsy-planned partnerships which do not have a partnership agreement.  This can be not only the product of ignorance, but also a purposeful avoidance of precepts which lock the partners into prescribed behavior.  One prodigious truth I learned in the days when I worked for a company was that management would insist on written policies to help govern activities, then more often than not these policies would be broken by management itself.  Partnership agreements are similar.

[jklcpa]

How about my first bold phrase where I said to follow tax law, specifically the concepts contained in IRC 707(a) and (c) that you made no mention of?  You should first review the tax law as it applies to the partnership agreement, how these payments are determined and their frequency as the starting point.  Unless the law is unclear or ambiguity existing in what these payments represent, only then would you jump into the court cases.

I think your initial suggestion of partner's "living expenses" being reported entirely as withdrawals and none as guaranteed payments is an unreasonable one.  If the partner is being paid "living expenses" of a consistent amount at regular intervals without regard to business profitability, then the payments would fall within the definition of guaranteed payments.

[Edsel]

Don't necessarily disagree with Judy in a perfect world.  And I agree totally that a single woman's living expenses, consistently running about $2,000 per month should be nothing but guaranteed payments.

And the aforementioned "perfect world" should be a worthy goal, and not unattainable simply because we are looking for excuses not to do what needs to be done.

But those of us in practice cannot force partners to draft a partnership agreement.  Self-described partnerships occur when a couple of guys show up with missing teeth and tell us "Duh--we're sorta partners."  And distributions are not planned or declared but instead result in the same fashion as "constructive receipts."  What's worse, they almost never in proportion to anything resembling a declared "split."  This leads to bizarre detail in the equity section.

Perhaps the best way to do everything right would be to simply refuse to prepare any partnerships for partners who cannot supply a partnership agreement, and I can't blame anyone if they take this position.  Around my part of the country, this will result in partners leaving me and going to shifty-eyed Sam on the other side of town.  Will not result in partners drafting a partnership agreement.

The particular partnership in question has been making minimal profits since its inception in 2014 - just enough for the managing partner to draw out living expenses - and yes I have always treated these as guaranteed payments.  However the partnership just won a major contract which will geometrically increase their profit beginning in 2019, and we are planning for the future.  A partnership agreement was drafted in 2014 but so much has happened since then that the agreement has not been able to morph into anything relevant in 2019.

Thanks to all - especially for Judy for shining the light on proper practice.

 

 

 

 

[Medlin Software, Dennis]

"Perhaps the best way to do everything right..."

This is a major part of my daily work struggles.  What I mean is the letting go of what my experience/training/preferences tell me is "right", and accepting I cannot control what others feel is acceptable.

 

[Catherine]

On 10/22/2019 at 12:18 PM, Medlin Software said:

accepting I cannot control what others feel is acceptable.

or what the clients are willing to do.

[Medlin Software, Dennis]

1 minute ago, Catherine said:

or what the clients are willing to do.

There is effeminately a line we all have.  Crossed today by someone asking how to change paychecks to the owner's name and SSN because the employees are not eligible to work in the US.

[Margaret CPA in OH]

"effeminately?" Not sure what kind of line that actually is given the definition I Googled.

[Catherine]

22 hours ago, Margaret CPA in OH said:

"effeminately?"

auto-UNcorrect version of "definitely" was my guess.