Partnership Equity question

[ConnorandCo]

Good morning, I have a complex situation involving a partnership that I need some advice on if possible. Scenario is as follows:

There are two partners. They each worked the first 8 months of the year in for the company without receiving any compensation at all. There idea was to have that time put into the company as equity, so instead of withdrawing money or compensation, just have it used as there share of the company.

Originally they had planned to become an "s" corp. and were going to use that as there stock in the company, however during the year, that changed and they elected to become a partnership.
Just to have a figure out there assume they each calculated up there work and time in the company at $80,000.00, now my plan was to credit partnership equity for each at $80,000, but what is the debit account for that entry?

[Bees Knees]

In essence, you are trying to give the partnership a monetary value in the equity account for the time the partners contributed to the partnership. The only way you can do that is to give the partners a monetary value for their time worked. Thus, if you are going to credit partnership equity for this "Phantom" dollar amount, then you have to debit some kind of labor expense, such as guaranteed payments, which as you know, causes the partners to each pay income and self-employment tax on their labor, as though the partnership paid them cash for their labor and they in turn contributed the cash back to the partnership in exchange for an equity interest in the partnership.

The alternative is to assign each partner a 50% profits interest in the partnership in exchange for their time and effort, with a zero dollar value assigned to their partnership equity account. The partners pay no tax on this profits interest because there is no guarantee the partnership will earn future income for the partners. The partners thus pay no tax until the partnership actually earns profits.

[taxea]

In essence, you are trying to give the partnership a monetary value in the equity account for the time the partners contributed to the partnership. The only way you can do that is to give the partners a monetary value for their time worked. Thus, if you are going to credit partnership equity for this "Phantom" dollar amount, then you have to debit some kind of labor expense, such as guaranteed payments, which as you know, causes the partners to each pay income and self-employment tax on their labor, as though the partnership paid them cash for their labor and they in turn contributed the cash back to the partnership in exchange for an equity interest in the partnership.

The alternative is to assign each partner a 50% profits interest in the partnership in exchange for their time and effort, with a zero dollar value assigned to their partnership equity account. The partners pay no tax on this profits interest because there is no guarantee the partnership will earn future income for the partners. The partners thus pay no tax until the partnership actually earns profits.

I agree with everything said except it is the partners responsibility to assign a profit/loss and expense interest through a written contract. I would first see whether they have one, and if not, have them create one that speaks to all terms of the partnership.

[Roland Slugg]

Thus, if you are going to credit partnership equity for this "Phantom" dollar amount, then you have to debit some kind of labor expense, such as guaranteed payments, which as you know, causes the partners to each pay income and self-employment tax on their labor, as though the partnership paid them cash for their labor and they in turn contributed the cash back to the partnership in exchange for an equity interest in the partnership.

Is that so? Let's see ...

If the partnership has no profit and pays the two partners nothing, neither partner will have anything to report on his own income tax return.

But if the partnership has no profit except for the $80,000 it pays to each partner, then it will have a net loss of $160,000. In that case each partner would report his $80,000 "guaranteed payment" less his 50% share of the $160,000 loss resulting in a net reported income of, well, zero.

Even if the partners want to do this, it won't create one dollar of basis ... so why bother?

[ConnorandCo]

partnership equity

I greatly appreciate your replies. Let me give a little bit more information on the issue. As of January 1st of this year, one partner had contributed 400k to the partnership. The other partner had contributed only around 10k, so on the K1's for last years return, the first year of operation, the partnership was in the 90/10 area. From the beginning they had agreed to not take a payroll for the first year, they were to use those leftover"wages" as more capital in the company, one make 10k per month the other 8k. I shouldn't have any issues with this in the tax return, but my problem is incorporating those "wages" onto the balance sheet. They aren't close to being 50/50 partners. No taxes of any sort were withheld or paid on these "wages" they took but left in the company. So I am trying increase the equity values on the balance sheet.

[Bees Knees]

Is that so? Let's see ...

If the partnership has no profit and pays the two partners nothing, neither partner will have anything to report on his own income tax return.

But if the partnership has no profit except for the $80,000 it pays to each partner, then it will have a net loss of $160,000. In that case each partner would report his $80,000 "guaranteed payment" less his 50% share of the $160,000 loss resulting in a net reported income of, well, zero.

Even if the partners want to do this, it won't create one dollar of basis ... so why bother?

The profits interest scenario is done when there are other capital interest partners who are not trading labor for their share of the partnership interest. For example, lets say the two partners trading labor for a profits interest also have a capital interest partner who is funding all the start-up costs. In that case, your example above would not be a net zero result. The same would be true also if it were just the two partners, but their capital interest and/or labor interest are not equal. Netting guaranteed payments with partnership losses might not net to zero for each.

But I agree if labor and capital are all 50/50, everything would net to zero, so why bother.

[DaveinTexas]

No disrespect but what in the world are you talking about and what is the goal here? If they each received no distributions and no Guaranteed Payments, what, if any, journal entries need to be made?

You have gross income minus expenses equals net income. 90% of the net income is fully taxable to the 90% partner and 10% to the 10% partner. Regardless of whether or not distributions are made, this fact remains true. Now, if you are trying to increase the 10% partner's basis in the partnership, this can't be done without an economic outlay of some kind...which will lead to the scenario Roland mentions.

You increase the capital accounts (equity) by not taking any distributions or guaranteed payments. So, essentially what they were trying to accomplish, increase equity by not distributing equity and not reducing profits by not paying themselves salaries (GP), has been accomplished.

"Sometimes we accomplish that what we set out to accomplish merely by doing nothing at all." Fake quote by no one.

[ConnorandCo]

No disrespect but what in the world are you talking about and what is the goal here? If they each received no distributions and no Guaranteed Payments, what, if any, journal entries need to be made?

You have gross income minus expenses equals net income. 90% of the net income is fully taxable to the 90% partner and 10% to the 10% partner. Regardless of whether or not distributions are made, this fact remains true. Now, if you are trying to increase the 10% partner's basis in the partnership, this can't be done without an economic outlay of some kind...which will lead to the scenario Roland mentions.

You increase the capital accounts (equity) by not taking any distributions or guaranteed payments. So, essentially what they were trying to accomplish, increase equity by not distributing equity and not reducing profits by not paying themselves salaries (GP), has been accomplished.

"Sometimes we accomplish that what we set out to accomplish merely by doing nothing at all." Fake quote by no one.

The goal was to find what my debit entry would be opposite the credit entry of the additional equity received from working in the company for 8 months with no monetary compensation. Only more of an equity position in the company. I was attempting separately list the equity positions of each partner on the balance sheet. The equity position had changed from the beginning of the year. I was going to credit "partner 2 equity" by a figure, and I couldn't come up with the debit entry.

[Lion]

So, he was awarded more equity for services rendered? Then payroll expense?