Topic 3: Reporting Partnership Income and Guaranteed Payments
[IRS Materials: Publication 541]
D. Determining a Partnership Guaranteed Payment Deduction and Allocation
1. In the last topic, mention was briefly made of the tax treatment of guaranteed payments. In general, any amount that is guaranteed to a partner without reference to the profits or loss of the partnership is treated as a guaranteed payment, deductible by the partnership in determining ordinary income (loss).
2. The amount of the guaranteed payment is reported to the partner on Schedule K-1. and is includable by the partner as part of his or her distributive share of ordinary income on Schedule E.
3. Since the guaranteed payment reduces ordinary income, all partners share the remaining ordinary income according to the profit and loss sharing agreement. Thus, the partner receiving the guaranteed payment will also receive a share of the ordinary income (loss) after deducting the guaranteed payment.
Example – Abe Allen, a 1/3 partner in the ABC partnership, is guaranteed a $10,000 payment each year without regard to the profits or losses of the partnership. During 2001, the ABC partnership generated ordinary income of $100,000 before deducting the guaranteed payment; thus, the ordinary income of the partnership after deducting the guaranteed payment is $90,000. Abe will report both the $10,000 guaranteed payment and 1/3 of the $90,000 ordinary income, or $30,000, as ordinary income shares on Schedule E. The other two partners will simply report $30,000 income shares on their returns, assuming each as a 1/3 interest.
Tip – This example provides a good illustration of the reasoning behind
the treatment of guaranteed payments. Since the $10,000 payment goes directly to Abe, partners B and C should not pick up any of the payment in their income shares. Deducting the payment in determining the ordinary income (loss) of the partnership guarantees this result.
4. In some cases, the partnership agreement casts the guaranteed payment as a “minimum payment ,” i.e. the partner is guaranteed a minimum dollar share of the ordinary income, in case the normal profit (loss) percentage share falls below this amount.
5. In such a case, the amount treated as the guaranteed payment is limited to the excess of the partner’s minimum payment over the computed income share; if the income share is large enough to cover the minimum payment, then there is no guaranteed payment.
Example – Jane Brown, a 40% partner in the XYZ partnership, is guaranteed a minimum income share of $30,000 each year. If partnership ordinary income before considering any guaranteed payments is $60,000, then her 40% share would only be $24,000, requiring the partnership to make a guaranteed payment to her of $6,000 ($30,000 minimum guarantee less $24,000 profits share). The partnership will deduct a $6,000 guaranteed payment, and Jane will report a $30,000 income share.
Example – Assume the same facts as the previous example, except that the partnership’s ordinary income before considering any minimum payment requirements is $90,000. In this case, Jane’s 40% share is $36,000, more than the guaranteed minimum income amount of $30,000. Thus, there are no guaranteed payments in the year, and Jane will report $36,000 ordinary income share on her Schedule E.