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Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 4020
Experience:  Extensive Experience with Tax, Financial & Estate Issues
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Hi there, I have recently started my first LLC (two years

Resolved Question:

Hi there,

I have recently started my first LLC (two years in). We are taxed as a partnership. Our member structure is as follows:

3 members with 25% each whom contribute services (the day to day operation) of the business.

1 member with 25% which made an initial contribution (not a loan) of $30,000.00

We recently filed our 2012 Taxes, and we believe there may be an error. Trouble is our current CPA, says there isn't but is not able to explain in plain english on why not. This also applies to our 2011 taxes. But since we were so new, we didn't question it till now.

In 2011 (when our LLC formed/business started), our accountant said the 3 member who did not contribute money had to "match" the 1 member that did. The Accountant made an entry in Quickbooks reflecting each member making a Equity/Member Contribution of $30,000.00 which he then split between 2011 and 2012. I believe this was that the 3 were providing services.

Our Accountant then made a journal from the contribution account to each of "operating" members (3) "guaranteed payment" accounts, again splitting between 2011 and 2012 ($15,000 each).

The "problem" lies is that this is reflected on our K1's under "guaranteed payments". So in 2011 and 2012 it shows each of the 3 members taxable income being $15000 (per year) more than what they took home.

We would like to know why we are getting taxed on our K1 for monies that the 3 members never actually received.

Thank you.
Submitted: 10 months ago.
Category: Tax
Expert:  Stephen G. replied 10 months ago.

Stephen G. :

Hello, my name isXXXXX & I'll be helping you today. My goal is to give you a complete & accurate answer that you can understand.

Stephen G. :

That is an unusual way to handle setting up your operation.

Stephen G. :

What he is trying to do is to make your equity accounts equal among the members.

Stephen G. :

As far as the guaranteed payments are concerned, those should have been expensed on your partnership return, so that your allocation of the partnership income would have been less than if he had not recorded the guaranteed payments.

Customer:

Exactly, after doing some research he set it up as if each member had to contribute the same amount in either monies or services to keep each member at 25%.

Stephen G. :

The only difference is that all 4 members would have benefited from the reduction of partnership income by the guaranteed payments whereas only 3 of the members would have reported the guaranteed payments as income.

Customer:

How the guaranteed payments are setup, I believe is fine. The "3" working members use that as their "paychecks".

Stephen G. :

Basically, it isn't as bad as it seems on the surface as those guaranteed payments have reduced your partnership income, so without them, your partnership income would increase.

Customer:

Ah ok I understand, so that we take a bigger "loss" with the way it is setup now.

Customer:

But I guess the problem is that the loss isn't has large as the $15,000 (at least for 2012)

Stephen G. :

Wait, does the partnership show a loss?

Customer:

Let me grab my K1

Customer:

"Ordinary Business Loss" = -1475. "Section 179 Deduction" = 5,391.

Stephen G. :

Well, that results in a couple of issues, but the main one is that if you didn't have any money in your equity accounts (the 3 partners), then you wouldn't be able to claim the loss or the Section 179 deduction.

Stephen G. :

What does the partnership do?

Customer:

Ah ok I understand that

Customer:

We are a Audio/Visual equipment rental company

Stephen G. :

OK

Stephen G. :

I understand what he's doing, you must have purchased a lot of equipment last year (your first year)?

Customer:

Not at all

Customer:

We are actually Brokers

Stephen G. :

Ok, well that's different

Stephen G. :

You must have purchased something this year, maybe vehicles?

Customer:

1 GMC "Box" truck for about $7,000

Customer:

And then of course some desks, printer, (basic office stuff)

Stephen G. :

the 179 deduction is 5K+ times 4 = 20,000.

Stephen G. :

Ok, none of those 179 expenses would have been deductible to the 3 of you without recording the capital contributions the way he did.

Customer:

Ah ok got ya.

Stephen G. :

the guaranteed payments are offset by reduced partnership income ie. it would have been income verses the small loss & the 179 deduction.

Customer:

I just looked at the 4562 and I forgot about some convertors and rental software (which was very expensive), so that is how me came up with the 21k #

Stephen G. :

ok

Stephen G. :

Do you understand what I'm saying about the relationship between the guaranteed payments and the partnership income?

Customer:

Yes I believe so. The guaranteed payments are an expense to the business (loss). So even though it shows an additional $30,0000 over two years as a guaranteed payment. The business still takes it as a loss, which means we take it as a loss individually

Stephen G. :

Right & the only difference is that the 15K x 3 is income to the 3 of you; but the expense to the partnership is divided by 4

Customer:

Exactly. Now if the 4th member does not actually contribute services or "work", he shouldn't be able to take the loss correct?

Stephen G. :

No. That's not correct. His 30K contribution entitles him to be an equal partner to the three of you; assuming that was the original deal.

Customer:

Ok I thought I read something about needing to actually contribute 250 (or some number) of set hours to be able to take a loss. But no worries.

Customer:

You answered my question, much appreciated. Now I can explain it to the other members in plain english.

Stephen G. :

That's another whole issue relating to Passive Losses; I'm sure your CPA has that covered.

Customer:

Let's hope :)

Stephen G. :

It's no big deal in any case.

Stephen G. :

If you need to contact me again with any tax or financial questions, you can just ask for "Steve G" at the beginning of your question. Thanks again for using us for your tax and financial questions. You may get a short survey from the site; if it isn't too much trouble I would appreciate it if you would answer it; the survey results are used to rate our performance;

Customer:

I have to run, but thank you so much!.

Stephen G. :

Thanks very much.

Customer:

I am not seeing where it say's

Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 4020
Experience: Extensive Experience with Tax, Financial & Estate Issues
Stephen G. and other Tax Specialists are ready to help you

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