Extremely biased distributions

[Stringbean]

In a partnership, the equity as presented should represent the ratio of ownership for each partner.
[Stop me right here if this is incorrect, because it gets worse].

Assume a 50-50 partnership, but one partner predominantly has contributed more than the other. In addition, this partner also withdraws almost all the distributions. Result is that the equity is anything but 50-50. Additionally, assume that no corrective action is foreseen or planned for the future, such that this will ever balance itself out.

Should the partnership be "forced" to balance out the equity accounts? If so, how? Here are a couple possibilities:
a) Reclassify one partners' distributions to Loans from Partners until the equity accounts are in balance.
b) Reclassify one partners' distributions to Guaranteed Payments until the equity accounts are in balance.

Of course, I don't know that either of the above are necessary, although if not at some point the 50-50 relationship would be in jeopardy. I checked TTB for this, and read about "special allocations" but there is no cause to launch this treatment.

Does the situation change if the partners are LLC members filing as a partnership?

[taxea]

Assume nothing...do you have a copy of the partnership agreement? What does it say? Unless you are their accountant this information should be provided to you by whomever keeps the books. If you are doing the Partnership return you need a P&L and balance sheet as well as the up to date basis document for the partners.

[Golden Rocket]

Generic Statements

Taxea, you didn't answer or address the situation. You made generic statements that would apply to any discussion involving partnerships.

[Roland Slugg]

Since neither of the above replies offers any useful information, I’ll see if I can help you sort this out.

In a perfect world it would be nice if partnerships always kept the partners’ capital accounts in sync, and in most large partnerships, they do. In many small partnerships, however, it is common (or at least it is not UNcommon) for partner distributions to vary from their percentage interests. You referred to these as “biased” distributions; in tax parlance they are called “disproportionate” distributions, and their tax treatment is covered by various sections of the IRC. The basic situation, which may apply to your situation is covered by Code §731(a) ... cash distributions not in liquidation. All partnership distributions reduce the receiving partner’s basis in the partnership, but not below zero, and if a distribution exceeds a partner’s basis, the excess is taxable gain.

The payments you described, however, may not be “distributions” at all. They may be “guaranteed payments” to the partner who seems to be getting the lion’s share, and if they are, they are taxable to him, and they have no direct effect on his capital account. They may also be installment payments toward the purchase of equipment he sold to the partnership. You did say, I believe, that one partner contributed more to the partnership than the other partner did.

What you need to do is talk to the partners. Find out why they are making disproportionate payments, and if those payments constitute “distributions,” or if they are guaranteed payments, loans, purchases of assets, or something else. You certainly should not force the partners to bring their capital accounts back into pro-rata equilibrium, nor should you arbitrarily adjust the partners’ capital accounts to bring them into the “correct” ratios. That’s not your job, and it really isn’t necessary. You should only find out the true nature of the distributions, account for them properly and advise the partners accordingly. It might be helpful to read the partnership agreement in order to gain an understanding of the basics, but no matter what it says, what has been done has been done, and your job is simply to account for it properly ... or so I am assuming.

Does the situation change if the partners are LLC members filing as a partnership?

No. It’s still a partnership, and the members are still partners. Hope this helps.

[TAXNJ]

Well said

Great replies by R. Slugg and TAXEA.

One short and one long but to the point. (Pratnershp agreement; classifications and partners tax capital accounts activity)

[Stringbean]

Flapping in the wind...

Thanks to all respondents, but especially to Mr. Slugg who really did provide information.

The conclusion I derive from Roland's comments is that it's OK to let the capital balances do whatever they will, irrespective of whether they remain in proper proportion. As long as the income is properly split, the partners can contribute or withdraw from the capital accounts and leave them flapping in the wind with whatever results from this. His post cautions against doing anything to "force" proportion without interaction with the partners, so the flapping will occur.

But I will say this to all the respondents about "reading the partnership agreement." The overwhelming situations which require a partnership return are seldom structured. It might be a couple dingbats show up in your office and tell you "Duhhh, we're sorta partners." Try getting a partnership agreement from that. Or a disproportionate distribution is "Because I needed it". Better yet, "Bubba had some money and I dint." Just try to explain to these morons that they can be denied deductions because of basis calculations and behold the vacant look in their eyes. These are the type of things that give rise to flapping capital balances, not the well-thought-out, business-minded people who become partners with the intent of equitable operations.

Fortunately (and mercifully), these types of situations don't last long. But unfortunately they last long enough for disproportionate equity to become a real mess upon dissolution. Often, I try to divert the filing of a 1065 into two Sch. C's.

[taxea]

Taxea, you didn't answer or address the situation. You made generic statements that would apply to any discussion involving partnerships.

I didn't realize I couldn't ask for more specific detail before giving him a response. What he provided was very vague.
Are you the Forum Cop?

[RitaB]

Triple your forum fun

I didn't realize I couldn't ask for more specific detail before giving him a response. What he provided was very vague.
Are you the Forum Cop?

Stringbean, Golden Rocket, and Corduroy Frog are the same person logging in from different computers. Pretty sure.

Oh buzzardbreath, too.

[taxea]

Thanks to all respondents, but especially to Mr. Slugg who really did provide information.

The conclusion I derive from Roland's comments is that it's OK to let the capital balances do whatever they will, irrespective of whether they remain in proper proportion. As long as the income is properly split, the partners can contribute or withdraw from the capital accounts and leave them flapping in the wind with whatever results from this. His post cautions against doing anything to "force" proportion without interaction with the partners, so the flapping will occur.

But I will say this to all the respondents about "reading the partnership agreement." The overwhelming situations which require a partnership return are seldom structured. It might be a couple dingbats show up in your office and tell you "Duhhh, we're sorta partners." Try getting a partnership agreement from that. Or a disproportionate distribution is "Because I needed it". Better yet, "Bubba had some money and I dint." Just try to explain to these morons that they can be denied deductions because of basis calculations and behold the vacant look in their eyes. These are the type of things that give rise to flapping capital balances, not the well-thought-out, business-minded people who become partners with the intent of equitable operations.

Fortunately (and mercifully), these types of situations don't last long. But unfortunately they last long enough for disproportionate equity to become a real mess upon dissolution. Often, I try to divert the filing of a 1065 into two Sch. C's.

I will no longer take on clients that don't know what they are doing.

[Stringbean]

Rita Knows

Yes, I'm guilty. Not only does each computer require a different login, each browser can require its own login as well.

"Stringbean" happened because of difficulty getting signed on a few nights ago and I kept getting prompted to register with a new name. So in honor of a truly honorable bluegrass icon, Stringbean was introduced to the forum. I provided only a minimum of profile information because of my haste to get a question posted. No attempt to hide identity who in reality is Ron Jordan.

I have been accused of being a "forum cop" before, as Snaggletooth - because of my overt criticism of the way people proliferate useless messages on these threads without contributing anything to the question. No desire to be a "cop" but you need only to look at this thread to read 8 replies to the OP, with only Roland Slugg actually addressing the question with any relevant subject matter. I won't belabor the point, as I've done enough of it recently.

Rita, we're 80 miles apart - come see me and my svelte physique sometime.

[RitaB]

Now you're talkin

Rita, we're 80 miles apart - come see me and my svelte physique sometime.

I would be delighted. Now there's a useful and informative post.

Since we're all over the place now, let me throw out my contribution to the useless information. I find it difficult to turn ANY client away, since I have two universities to pay, and they are hogs, lemme tell you. Sometimes you just gotta do the best you can to inform the uninformed. And, then there's the guy I met Tuesday with $15,700 in lodging expense and 53,000 business miles, aka, The Least Credible Man On Earth. I told him I wasn't qualified to prepare Schedule PAM - Please Audit Me. You gotta pick your battles, I guess.