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Tax Return Analysis

Where are Guaranteed Payments on a 1040?

Michael’s question:

My question is about 1065, K-1, Part III section 4 Guaranteed Payments. In Lender’s Online Training you taught us that guaranteed payments are cash flow, and that we should reframe the word ‘guaranteed’ to ‘agreed upon’ payments since if the company does not have sufficient operating cash flow to pay them, they probably are not actually guaranteed. Do these payments show up anywhere on the individual’s tax returns?

Linda’s answer:

The quick answer is yes. But it is not obvious. There is no place in the 1040 where it indicates that ‘Guaranteed payments’ should be listed.

Hidden on Schedule E

1040 Schedule E Part II is ‘Income or Loss from Partnerships and S Corporations’ and is on page two of the schedule. Guaranteed payments are combined with Ordinary Income (from Line 1 of the K-1) and reported either as passive income/loss if the owner is more like an investor, or nonpassive income/loss if the owner is active in the business.

How can guaranteed payments ‘turn into’ a loss?

They don’t. But if the ordinary loss is greater than guaranteed payments, the combination can be a loss.

When can you use 1040 Schedule E, Part II for cash flow, since guaranteed payments are cash flow?

Never, because the guaranteed payments which are cash flow are combined with ordinary income which is not. The tried-and-true method of determining actual cash flow to an owner from a 1065-filing entity (partnership or multi-owner LLC) is to obtain the K-1s.

More help on K-1s

Michael was enrolled in the full online training for Global Tax Return Analysis. Not a surprise, I highly recommend it. Participants report a 31% increase in their competence and confidence in analyzing borrower tax returns after taking the 22-module, 4-webinar course which include access to two 200+page reference manuals and the opportunity to submit your own analysis of two comprehensive tax returns for personalized feedback.

And still more

K-1 Video Series for Bankers

We also have a complimentary resource for you to improve your understanding of K-1s and Pass-through entities. Click here to request our free 20-video series on K-1s.

About the Author
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.