How should we account for guaranteed payments owed to the partners?

Thanks for the tips.  I've altered our CoA so that guaranteed payments are an expense, while 'Guarantee Payments Owed' is a (other current) liability.

One thing about recording guaranteed payments owed as a liability is that they show on both cash-based and accrual-based reports.  Is that appropriate?  I feel like deferred guaranteed payments should not show on cash-based reports.

True cash based does not have payables or liabilities, so QB is showing a modified cash basis report.  The best thing for this question is to get with a local tax accountant, since that is where it matters the most

I have a question along these lines, which has not quite been answered in this discussion:


How are deferred guaranteed payments treated? (e.g member's guaranteed payment that is owed but has not been paid, because capital is limited)

This is what I have so far:

- Work has been performed
- Guaranteed payments are owed
- Cash has not been delivered

If we create a Payable Liability, the other journal entry should be a salary expense. But if the entity records the expense, the guaranteed payment (which was not sent) needs to be reported on the member's K-1 and recognized as income. However, they have not yet actually received the income and do not want to pay taxes on what they have not yet received.

How should the outstanding Payable Liability be accounted for (if it cannot be posted as a liability/expense)?

My guess is that it should be a disclosure in the footnotes that an outstanding payment is owed.

Please help me clear up my uncertainty.

Yes the unpaid guaranteed payment would post to guaranteed payment expense (technically not salary expense) and to a liability account.

Then the reporting basis for taxes comes into play, cash based reporting only reports cash.  Accrual based reporting would pick it up, but in accrual you are also being taxed on the K-1 on income booked but maybe not paid too.

Is there any best practice that does not create the liability/expense in the current period (i.e. defers the guaranteed payment)?

The partner does not have the money to pay the taxes on the guaranteed payment since they have not yet received it (and do not expect to receive it before tax deadlines).

I have 2 guesses, but no evidence to support either:

1) It can be a disclosure in the footnotes that an outstanding payment is owed (effectively kept off B/S).
2) It is somehow related to 409a and can be expensed by the entity and deferred by the individual

#2 - sounds wonky

#1 - It seems to me that since the partnership agreement provides for guaranteed payments (It must be stated in the partnership agreement to be a legal expense - otherwise you can not do guaranteed payments and the money is an equity draw)  then you have to either pay the payment, or accrue the liability.  I do not see a way around that, sorry.

Without paying out expenses, you end up reporting more taxable income and paying taxes on it.

It is time to ask your own CPA, since you are asking for Tax rule guidance. A QB peer user forum is not the place to ask questions that are for Tax professionals.

I think you should ask your own CPA, because if this was me, I would be making the Expense entry as "Redeposited" as Partner contribution for Equity, not as liability. You should ask if there is no reason you cannot treat this as "reinvested" instead of "owed."

Your financial reports will look better.

That's an interesting idea, although I'm not sure it will work for us:  Our partners's guaranteed payments are unequal - proportional to their labor/service to the company, not to their ownership.  Some partners receive no guaranteed payments because they provide no services to the company.

Reinvesting the guaranteed payments would change the balance of equity in the company, something we'd like to avoid (and governed by special provisions in our operating agreement anyway)

"I feel like deferred guaranteed payments should not show on cash-based reports."

When you use Journal Entries, you bypassed that differentiation and made a brute force accounting entry that always shows on both bases.

"Reinvesting the guaranteed payments would change the balance of equity in the company, something we'd like to avoid (and governed by special provisions in our operating agreement anyway)"

Which is why all of us refer you to your own CPA for this Accounting Guidance question.

It does not seem like a consensus has been reached here. The scenario at the top seems to say that the Guaranteed Payment is categorized in an expense account and unpaid amounts are accrued in a liability account. This seems logical to me. It is not clear to me if the first answer is in agreement with this method because of the later discussion of the equity accounts.

At our startup, we are faced with the same scenario as discussed above. We make guaranteed payments to accommodate a disparity in work effort relative to partner interest stake. In other words, the partner doing all the work makes a living wage before distributions are made to the partners that include silent investing partners.

Everything would work fine if a Guaranteed Payment was actually guaranteed in a startup company but it is not. The problem with all the internet chatter on this matter is that the definition of Guaranteed Payments is always copy/pasted without a discussion of what happens when you can't make a full payment. If you copy paste the definition, the language states that the payment is made regardless of profit or loss. This works if you have investors that make up the difference during the period of a net loss on the P&L. When a startup is living on a cash basis and there is no cash, the bank account does not allow for a negative number. The solution is that the partner who should be getting a Guaranteed Payment (GP) defers the payment.

I understand the desire, however, to record the deferment in order to keep track of the sacrifice one partner is making. At a later date, that partner should have the option to either receive his deferred GPs ahead of partner distributions or dissolve the debt.

From an accounting perspective, I don't see any legitimate way to classify the deferred payment as a capital contribution or people would say that their GPs are $1M/mo but they can only pay $10,000/mo so the remaining $990,000 is a capital contribution. This would sure be a great tax benefit on the sale of the company.

An equity draw seems to be a common discussion and the concept of three equity accounts, but it really does not address the purpose of Guaranteed Payments to account for partners with a disparity in effort relative to interest stake.

So in the end, here is my problem. If you don't record the full GP as an expense on the P&L you don't have a clear picture of the companies performance. In other words, you can artificially make the company look like it is breaking even by shifting an unpaid GP to a liability account. While I agree that one should base performance on all three statements, the P&L speaks very loud and it is difficult for silent partners to understand why they are not getting distributions when the P&L is black.

If you record the GP in full but don't actually pay the GP, the partner who should have received it will have great heartburn on tax day.

For me, this long discussion supports the original question/statement of method. My question is to ask, where I am going wrong?

The difference in Sweat Equity and wanting to pay out relative to acknowledging this is why Partnerships elect to be treated as an S Corp. Now there is Payroll.

You need to review all of this with your own CPA, so that you Follow the tax regulations that apply.

Is anyone else able to chime in on this thread, because I have a similar situation.

How are (deferred) guaranteed payments treated if a member is owed but has not been paid, because capital is limited.

This is what I have:

- Work has been performed
- Guaranteed payments are owed
- Cash has not been delivered

If we create a Payable Liability, the other journal entry should be a salary (guaranteed payment) expense. But if the expense is taken, the guaranteed payment needs to be reported on the member's K-1 and recognized as income. However, they have not yet actually received the income and do not want to pay taxes on what they have not yet received. Therefore, I cannot account for it as a Liability because I cannot expense it this period. But a Liability does exist and will be paid...

How should the outstanding Payable Liability be accounted for? I have 2 guesses, but no evidence to support either:

1) It should be a disclosure in the footnotes that an outstanding payment is owed.
2) It is somehow related to section  409a and can be expensed by the entity and deferred by the individual.


Please help me clear up my uncertainty.

I had a similar question as well. I am setting up a partnership for a client of mine on QuickBooks Online. I created three accounts for the partners like Partner's Contributions, Partner's Distributions and Partner's Equity. Now the partners don't have the same percentage of the business, like the one has 97% and the other 3%. One of them gets paid for their services to the partnership, the 3% partner. How do I record that payment under which account does it go to (Do they also get a 1099 to show they got paid?) and also how do I record the retained earnings? Like do I create a retained earning for each partner since they do not have equal percentage. Does QuickBooks Online have something that I can put the percentage of each partner so it does it automatically? Do the partners each get taxed on their own individual portion of the income? Do I need to manually do journal entries in order to put everything in the right place (like retained earnings, etc.)? If one partner doesn't ever take out of the business they are still taxed on their retained earnings correct? How do I create an owner's draw for each partner on QuickBooks online? I appreciate all the help and advice that I get since this is my first time doing a partnership.

@qbteachmt - Must agree with you on this.  LLC is such a wildcard in my world. Every one of my clients who set up as LLC files taxes as an S Corp.  One reason as is noted, Guaranteed Payments are intended to be paid, not deferred.  In my industry, Guaranteed Payments must be paid timely or they can't be billed to Govt customers.  I heard Partnerships are the most common IRS audits.

I recall as far back as Accounting 101 in the 1980's we were all warned to avoid Partnerships.  

Rustler,

for Guaranteed payment, do i just create chart of account type of expense and call it Guaranteed payment and pay the partner. How is this different then owner withdraw? what is the pro & con? 

In QB I am looking to add a guaranteed payment to the expense account.  However, in doing so, I see the note below.  If not Payroll expense, what is the correct expense account for the guaranteed payment?

 

Use Payroll expenses to track payroll expenses. You may want different accounts of this type for things like:

• Compensation of officers
• Guaranteed payments
• Workers compensation
• Salaries and wages
• Payroll taxes

Thank you