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  • Are 'Guaranteed Payments' really guaranteed?


The short answer is ‘no’. Oh, want more?

Poor choice of words

I wish the IRS would check in with me before they name things. But they don’t … yet.

The word guaranteed usually means:
A promise, assurance. But not on a 1065 K-1.

So what does it mean?

From IRS Publication 541:

Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership’s income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner.

This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner’s distributive share of ordinary income. Guaranteed payments are not subject to income tax withholding.

Linda Keith’s interpretation:
Typically a guaranteed payment is made to a partner for whom the profit/loss split agreed between the partners would not result in a fair distribution. This may happen when one 50/50 partner is working 40 hours a week in the business and the other 50/50 partner is working only 20 hours.

It would not be fair to split the profits 50/50 so they pay themselves for their time (guaranteed payments) and once that is expensed they split the remaining profits 50/50.

How does that impact your cashflow calculation?

Actual cashflow from a 1065 K-1 is:

Withdrawals or distributions
Plus Guaranteed Payments
Minus Capital Contributed

You may want to check that the distributions are actually cash instead of property and the capital contributions are typical before counting either.

How does that impact your impression of cashflow?

Just understand that ‘guaranteed’ in this case does not mean promised or assured. It means it is a payment not related to the agreed profit/loss split…that’s all.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.