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Partnership guaranteed payments and the 199A Deduction

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  • The White Coat Investor The White Coat Investor 
    Keymaster
    Status: Physician
    Posts: 4070
    Joined: 05/13/2011

    I wish I’d written this. If you’re a physician partner, you may just now be learning that guaranteed payments (box 4 on K-1) aren’t eligible for the Section 199A deduction. There is a work around, but it might not work for you. It’s definitely worth checking though.

    Salvaging Partnership Section 199A Deductions

    The workaround? A partnership may choose to pay out its profits without using guaranteed payments and other than on the basis of capital account percentages–or what tax law calls Section 704 special allocations.

    In other words, the partnership doesn’t pay out profits to partners using some rule that ignores partnership income such as “each working partner receives a guaranteed $10,000 a month no matter what happens in the business.” (This arrangement counts as a guaranteed payment.)

    And a partnership doesn’t allocate profits based on a simple percentage such as “Steve, you own 25 percent of the partnership so the tax return allocates you 25 percent of the partnership’s income.” That turns out to be too inflexible for a partnership of working partners–like a law firm or physicians’ group practice–where partner incomes need to reflect partner contributions.

    Instead, the partnership allocates its profit using some different, more complex formula documented in the partnership agreement and based on the income of the partnership and the contributions of the partner.

    A professional services firm, for example, might allocate partnership income based on the revenue production of the partner. Or on the marketing she or he does for the firm–which doesn’t generate direct profits but aids the firm in its marketing. (What if the partner writes a tax column for a national business magazine.)

    This approach might mean some partner who previously received (say) a $120,000 of guaranteed payments and $30,000 of profit allocation would instead receive $150,000 of profit allocation. And that would mean, in this simple example, that the Section 199A deduction goes from 20 percent of the $30,000 to 20 percent of the $150,000.

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #180325 Reply
    Avatar jacoavlu 
    Moderator
    Status: Physician, Small Business Owner
    Posts: 1691
    Joined: 03/01/2018

    we discussed this some here, in the context of the seeming disadvantage of S corp compared with partnership structure for those physicians that can stay under the QBI deduction phaseout: https://www.whitecoatinvestor.com/forums/topic/partnership-advantage-over-s-corp-practice-setup-with-199a-deduction/

    the article that I really want to see is the one loosely titled: “Hey physicians with S corp practices. Considering converting to a partnership? Here are the pros, cons, and roadblocks. Now hurry up and figure it out.”

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #180329 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1507
    Joined: 02/01/2016

    Keep in mind that employer retirement plan contributions can not be based on K-1 distributions.

    If you want to make 401k contributions, you will want partner compensation >= (402g limit / (1.0 – maximum employer contribution)), but not < (402g limit / (1.0 - 0.765 = 0.9235)) With a one-participant 401k plan this is $19K / 0.75 = $25,333. With a safe harbor 401K plan this is $19K / 0.9235 = $20,574.

    #180363 Reply

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