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How is QBI Impacted by Guaranteed Payments and Operating Agreements.

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Level 1
last updated ‎April 11, 2019 2:51 PM

As I understand it Guaranteed Payments from a partnership or LLC reduce the use of the 20% reduction in taxable income when it falls within the qualifications regarding a 1065. My guess is that this misfortune will not pertain to a one person LLC which is planted on a 1040 schedule C?

Regarding a 1065 situation my question is what will the IRS expect to see on the Guaranteed Payment line?  What is their exact definition or requirement for that line besides medical insurance and anything found in an operating agreement?  My guess is that many K-1s will show very little on that line and perhaps the "distribution" line absorbing most of the activity.  Section 707(c) does little to give us guidance on the issue.  It is quite vague.  For the small family owned 1065s I see the second partner, if a wife or other relative having only 1% to 10% of the shares being dropped reverting it to a One Person LLC.  AND......what if there is no operating agreement.  What would IRS expect to be put on that line? Wouldn't these new rules require every LLC to have an operating agreement?  If so it still could be orchestrated to show little requirement for guaranteed payments.   However if the IRS is going to default to a definition unannounced to date to reflect some fair market value of services performed to be put there it would defeat the whole purpose of a small business being a two or more person LLC vs a One Person LLC or a proprietorship.  The rule makes no sense to me unless I am missing something.  What say you?    Thank you. 

 

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Employee
Employee
last updated ‎April 11, 2019 2:51 PM

GI Joe, thank you for your service. Guaranteed payments are usually used like salary in a Partnership, and will reduce the Qualified Business Income (QBI) from the Partnership, but they are not counted as Wages for the QBI Wage/ Asset limitation rule. You are correct that guaranteed payments do not exist on a Schedule C, or a single member LLC filed on a Schedule C, however the net income from Schedule C is reduced by 3 Self-Employed items (½ SE tax, SE Health Insurance deduction, Pension deduction) to get QBI from a Schedule C.

For a 1065, there is no requirement that guaranteed payments be populated- it is based on the operating agreement or up to the operating partners. I suspect this year, the collective GPs will go down, and the 1065 Ordinary Income will increase, as a logical extension of tax strategy.  No idea if IRS will expand guidance about GPs in the future.


To see how QBI, Wages and GPs interact across entity types, you may want to play with the Entity Selection Calculator here:  https://proconnect.intuit.com/tax-reform/entity-selection-calculator/

Hope this helps.

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Highlighted
last updated ‎April 11, 2019 2:51 PM

Section 707(a) and Section 707(c) and associated regulations pretty explicitly define the payments to partners that get excluded from QBI.

Section 707(c) says this about guaranteed payments, for example:

(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...

A partnership should be able to, in many circumstances, rewrite their partnership agreement so that rather than use Section 707(c) payments, they use special allocations. (Er, this probably should have been something a practitioner talked with clients about in early 2018... if someone didn't do that, though, the delay can maybe be attributed to wanting to wait for the final regulations.)

I wrote a blog post about this business of salvaging partnership Section 199A deduciton here:

https://evergreensmallbusiness.com/salvaging-partnership-section-199a-deductions/

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Employee
Employee
last updated ‎April 11, 2019 2:51 PM

GI Joe, thank you for your service. Guaranteed payments are usually used like salary in a Partnership, and will reduce the Qualified Business Income (QBI) from the Partnership, but they are not counted as Wages for the QBI Wage/ Asset limitation rule. You are correct that guaranteed payments do not exist on a Schedule C, or a single member LLC filed on a Schedule C, however the net income from Schedule C is reduced by 3 Self-Employed items (½ SE tax, SE Health Insurance deduction, Pension deduction) to get QBI from a Schedule C.

For a 1065, there is no requirement that guaranteed payments be populated- it is based on the operating agreement or up to the operating partners. I suspect this year, the collective GPs will go down, and the 1065 Ordinary Income will increase, as a logical extension of tax strategy.  No idea if IRS will expand guidance about GPs in the future.


To see how QBI, Wages and GPs interact across entity types, you may want to play with the Entity Selection Calculator here:  https://proconnect.intuit.com/tax-reform/entity-selection-calculator/

Hope this helps.

View solution in original post

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