Guaranteed Payments - Sort Of

[Snaggletooth]

Is it possible for a "limited" partner to receive guaranteed payments?

I'll confess to not knowing the answer, but it appears as though the two terms - limited partner and guaranteed payments - are an antithesis on the very face of it.

And it turns into a reporting problem. I have a partnership where one of the partners is receiving an extra $2000/year before any of the remaining partners receive ANYTHING. Then ALL partners (including the favored one) receive their prorated share of remaining earnings.

The guaranteed payment is because 30-40 years ago, this partner took care of the aged parents of the other partners. These parents died several years ago, but the remaining partners vested this guaranteed payment arrangement for as long as the caretaking partner shall live.

The caretaking partner herself is now in the nursing home, unable to take care of herself, and the thought of her paying Self-Employment tax on these guaranteed payments is ridiculous. Yet this is how the partnership is reporting the situation, and I believe this treatment to be correct, in spite of the idiosynchracies being created.

It also goes without saying that the favored partner has no part in the management of the partnership itself. Were it not for the guaranteed payments, I could make a case for this partner being a "limited partner."

What say ye??

[taxxcpa]

Guaranteed payment

Whether you call him a limited partner or not, if you call it a guaranteed payment it would be subject to social security.

It seems that it is NOT a guaranteed payment. It is more like a personal expense of the other partners and would be a withdrawal that would reduce their capital account rather than a deductible expense.

[JoshinNC]

It is a guaranteed payment

Any payment to a partner for services rendered that is not related to the pro rata share of the income from the partnership that is "required" by a written agreement is a guaranteed payment. If it's just a verbal "agreement" between the partners to pay a specific amount then book it as a distribution, as these are not subject to SE (or any tax in many cases) and do not need to be pro rata.

[Ken]

guaranteed payments

Snag, if you use the taxbook as a scource of information it has your answer on page 20-5. At the bottom of the page it says Guaranteed payments are subject to SE tax for BOTH general and Limited partners.

[JoshinNC]

I think Snag had that part figured out

Snag, if you use the taxbook as a scource of information it has your answer on page 20-5. At the bottom of the page it says Guaranteed payments are subject to SE tax for BOTH general and Limited partners.

I believe the crux of his question is does this payment qualify as a GP, or could it be treated as a different type of payment.

[Roland Slugg]

Snag, at the top of your post you asked...

Is it possible for a "limited" partner to receive guaranteed payments?

... implying that the partnership is a limited partnership and the partner in question is a limited partner.

But then at the end of your post you wrote...

Were it not for the guaranteed payments, I could make a case for this partner being a "limited partner."

Well, is it a Limited Partnership ... or a General Partnership? And if it's the former, is the favored partner a Limited Partner ... or a General Partner?

Hey, here's a novel idea: Look at the partnership agreement. This straightforward approach should answer both questions rather easily. And while you're at it, see what it says about that $2,000. If it's a guaranteed payment, it may be clearly spelled out right there. (FWIW: For each of my partnership clients I insist on being provided with a copy of the actual, signed partnership agreement, which I keep in the permanent file.)

You also offered this opinion:

The caretaking partner herself is now in the nursing home, unable to take care of herself, and the thought of her paying Self-Employment tax on these guaranteed payments is ridiculous.

Why is that ridiculous? A taxpayer doesn't have to be working to have S-E income. All that's required is an ownership interest in a profitable unincorporated business.

[Snaggletooth]

Answers

Ken - good to hear from the barber at Sierra Vista. Stick around - this board is just as good now as it was then. Thanks for pointing that out.

Sluggo - lotsa issues raised with the OP, which I didn't want to be more complicated than necessary. But fact is, this is NOT a publicly traded "limited partnership" such as a REIT, in the classic sense. And even such an entity requires at least one "active" partner.

But that doesn't mean all partners are active. In fact, only the son of one of the partners is "active" in the management. My question has a lot to do with whether this makes the other partners "limited" or not. The impact obviously involves SE tax, and passive suspension of losses.

The partnership agreement? CPAs get a lot more compliance when they ask to see these things than tax preparers do. We get told it was all verbal from the beginning and no one wanted to pay a lawyer, or even if they did none of the partners have seen the thing in years and no one knows where it is, etc. etc. etc. "Purist" tax preparers would file very few partnership returns if they insisted on seeing written partnership articles.

Self-employment tax on a nursing home patient IS ridiculous. Maybe legal and according to code, but ridiculous nonetheless. Although I prepare the 1065, I don't know what this partner's preparer does with the SE tax. If it were me, I guess I would be constrained to pay the SE tax.

[JoshinNC]

Snag

Ken - good to hear from the barber at Sierra Vista. Stick around - this board is just as good now as it was then. Thanks for pointing that out.

Sluggo - lotsa issues raised with the OP, which I didn't want to be more complicated than necessary. But fact is, this is NOT a publicly traded "limited partnership" such as a REIT, in the classic sense. And even such an entity requires at least one "active" partner.

But that doesn't mean all partners are active. In fact, only the son of one of the partners is "active" in the management. My question has a lot to do with whether this makes the other partners "limited" or not. The impact obviously involves SE tax, and passive suspension of losses.

The partnership agreement? CPAs get a lot more compliance when they ask to see these things than tax preparers do. We get told it was all verbal from the beginning and no one wanted to pay a lawyer, or even if they did none of the partners have seen the thing in years and no one knows where it is, etc. etc. etc. "Purist" tax preparers would file very few partnership returns if they insisted on seeing written partnership articles.

Self-employment tax on a nursing home patient IS ridiculous. Maybe legal and according to code, but ridiculous nonetheless. Although I prepare the 1065, I don't know what this partner's preparer does with the SE tax. If it were me, I guess I would be constrained to pay the SE tax.

I don't think an LP needs to be publicly traded, it just needs to have at least one limited partner (and, of course, one general partner), as opposed to a GP which has only general partners. This is specifically tied to the partnership agreement, an abscence of which would lead to a general partnership where everyone is a general partner.

[Roland Slugg]

Whether or not a partner is a "limited" partner has nothing to do with his level of involvement in the operations of the business, nor does it have anything to do with the partner's ownership percentage. And a partnership doesn't have to be a PTP or a REIT to have limited partners. A "Limited Partnership" (LP) is a creation of State law. Such a partnership declares in its partnership agreement that it is a LP and registers as such with its state's Secretary of State. Each general partner in a LP is named as such, and each limited partner in a LP is named as a limited partner. A limited partnership can have any number of general partners and any number of limited partners (as long as it has at least one of each). I once had a LP client that had ONE general partner and ONE limited partner. The general partner owned a 5% interest in the profits, and the limited partner owned 95%.

If your partnership client is not legally registered as a LP (or as a LLLP), then it is a general partnership, and all its business profits (after certain adjustments) are treated as SE income ... even those profits allocated to sweet old ladies in nursing homes. You might not like it, she might not like it, and I might not like it, but that's the way it works.

(LLLP's are relatively new, and only a few states ... about 15 ... have enacted enabling legislation allowing them. I don't believe that either TN or AL has done this.)

[smithtax]

One can also hold both GP and LP interests in the same partnership.

[JoshinNC]

What Roland said

Whether or not a partner is a "limited" partner has nothing to do with his level of involvement in the operations of the business, nor does it have anything to do with the partner's ownership percentage. And a partnership doesn't have to be a PTP or a REIT to have limited partners. A "Limited Partnership" (LP) is a creation of State law. Such a partnership declares in its partnership agreement that it is a LP and registers as such with its state's Secretary of State. Each general partner in a LP is named as such, and each limited partner in a LP is named as a limited partner. A limited partnership can have any number of general partners and any number of limited partners (as long as it has at least one of each). I once had a LP client that had ONE general partner and ONE limited partner. The general partner owned a 5% interest in the profits, and the limited partner owned 95%.

If your partnership client is not legally registered as a LP (or as a LLLP), then it is a general partnership, and all its business profits (after certain adjustments) are treated as SE income ... even those profits allocated to sweet old ladies in nursing homes. You might not like it, she might not like it, and I might not like it, but that's the way it works.

(LLLP's are relatively new, and only a few states ... about 15 ... have enacted enabling legislation allowing them. I don't believe that either TN or AL has done this.)

I agree. Word!

[JoshinNC]

Yes

One can also hold both GP and LP interests in the same partnership.

Most hedge fund managers own a very minute GP interest, and also own an LP interest just like their investors. It's the whole "carried interest" argument.

[Burke]

It's the whole "carried interest" argument.

Good thread on this subject. PS: I have always been curious as to how this term "carried interest" was developed. Does anyone know?

[JoshinNC]

It's a derivative of "the carry"

Good thread on this subject. PS: I have always been curious as to how this term "carried interest" was developed. Does anyone know?

Bascially, the manager is "carrying" his investors across a specified growth rate (the hurdle rate) and for doing all this "carrying" he is getting compensated with his "carried interest", which is basically just a limited partner interest that he retained for himself.

[Snaggletooth]

Thanks to All

Thanks to everyone, as someone has already said, this was a very good thread. I know much more than I ever hoped for when I posed the question originally.

I want to say also that I learned a remedy for the situation I referred to about "partners" not being able to produce a partnership agreement. OK guys, no agreement or articles results in a default "general" partnership with all partners being "general" partners.