A guaranteed payment is a payment by the partnership that is made without regard to the income of the partnership (meaning the payment is guaranteed even if the partnership doesn’t have a profit). The partnership’s deduction for guaranteed payments will reduce the qualified business income (QBI) that is passed through to the partners, as the guaranteed payment is properly allocable to the trade or business and is otherwise deductible for federal income tax purposes. These payments are excluded by the partners from QBI, meaning the partner can’t add them back for purposes of calculating their QBI income. So, you may ask, can you reduce or not pay a guaranteed payment in order to increase QBI benefits?
The answer, as with most tax questions, is complicated. This may be a viable option, but it’s not necessarily recommended. Depending on how the partnership operating agreement is written, it may need to be changed. If this is the case, the change would need to be made by the due date of the partnership return (not including extensions) to apply to the current year. Even taking this step is not a guarantee that the change in guaranteed payment structure won’t be scrutinized by the IRS. There needs to be a good business reason for the change, or the IRS may recharacterize the arrangements.
Another consideration is that altering guaranteed payments may not have the desired economic effect for the impacted partners, so besides evaluating the business purpose, you would want to consider the overall impact to the partners.
Before you start altering guaranteed payments, we recommend meeting with your tax professional to consider all potential impacts of making such a decision. To discuss your particular situation, please contact us today.
By Christina Larkin, CPA, CFP®