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Lev, Tax Advisor
Category: Tax
Satisfied Customers: 29965
Experience:  Taxes, Immigration, Labor Relations
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Can guaranteed payments in an LLC vary depending on income

Customer Question

Can guaranteed payments in an LLC vary depending on income of the LLC? In other words, can you increase GPs when you have more profit available in the company, then reduce them when profit is low?
Submitted: 2 years ago.
Category: Tax
Customer: replied 2 years ago.
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Expert:  Lev replied 2 years ago.
Hi and welcome to our site!
I assume that your LLC is taxed as a partnership - correct?
If so - guaranteed payments are NOT directly based on the LLC's profit.
A guaranteed payment is deducted in the computation of partnership income. Accordingly, it is considered a payment made to one who is not a member of the partnership and is deducted in full, just as if it were an ordinary expense under IRC section 162.
While for the partner - that makes no difference - either guaranteed payments or distributions made to partners are generally treated similarly on the individual tax return - that might affect the tax treatment on the partnership tax return.
A guaranteed payment is an amount paid to a partner that is determined without regard to the partnership income and is made to a partner acting in his or her capacity as a partner. Additionally, the amount paid must be deductible under IRC section 162 as an ordinary business expense. Thus, some payments or payments that are capitalizable are not deductible under IRC section 707(c).
So why even make the distinction between IRC section 707(a) and IRC section 707(c)? One of the most important reasons is the timing of receipt of income by the partner. Guaranteed payments are always includable in the partner's taxable income as of the end of the tax year in which the partnership deducts or capitalizes the payment. On the other hand, payments made under IRC section 707(a), and considered paid to a non-partner, retain their character and timing based on the nature of the payment and the accounting method of the partner.
So back to your question - whether guaranteed payments could be based on LLC's profit - yes - that is possible - for instance as a bonus which may be based on business profit - but still that should be a payment made without regard to being a partner - like a compensation for services in place of wages - but it could be based on the partnership agreement.
Let me know if that answered your question.