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I'm trying to figure out how a partnership "deducts"

I'm trying to figure out...
I'm trying to figure out how a partnership "deducts" contributions to a partner's retirement plan
JA: The Expert will know how to help. Please tell me more, so we can help you best.
Customer: Partnership pays the partner a significant guaranteed payment, and then provides a contribution to a retirement plan. Does the partner's capital account/basis adjust for their contribution to the retirement plan? or does it adjust for their % ownership of the partnership?
JA: Is there anything else the Expert should be aware of?
Customer: no
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Answered in 9 minutes by:
9/8/2017
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,150
Experience: Taxes, Immigration, Labor Relations
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There are two types of contributions - employee elective deferrals and employer contributions.

For purposes of qualified tax deferred retirement account - partners are treated as employees.

.

SEP is set under the partnership - and contributions are made by the partnership ONLY.

Contributions must be set as a percentage of compensation.

And that MUST be the same percentage for every partner and every employee.

The maximum allowed contribution is 25% of compensation.

.

401k plan allows both types of contributions.

Employer contributions are subject to same rules as for SEP - see above.

The limit on employee elective deferrals (for traditional and safe harbor plans) is:

$18,000 OR total compensation whatever is less.

Plus additional catch-up contributions for those above 50.

To determine actual contribution limit - we need to know the amount of compensation - mainly - self-employment income passed to partners on K1.

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Customer reply replied 2 months ago
Initially the partnership had a defined benefit plan. After two years the plan was changed to a 401k plan. The two partners take equal amounts for guaranteed payments. In the initial year, things look like this:
.....................................partner 1...............partner 2
beginning capital....................0........................0
Net income...................281,000...................15,000 (after deducting guaranteed payments)
retirement................. - 53,000.................. - 53,000
capital........................228,000................. - 38,000Each partner was paid a guaranteed payment of approximately $250,000 (i.e. a total of $500,000)
Customer reply replied 2 months ago
There is no debt on the books. The retirement plan contribution was funded before 12/31. So does this mean that partner 2 has a negative basis? You can't have a negative basis. Does partner 2 get a special allocation to restore the capital account? the partnership agreement doesn't require deficit restoration.

See instructions - page 10 -

http://www.irs.gov/pub/irs-pdf/i1065sk1.pdf

Payments made on your behalf to an IRA, qualified plan, simplified employee pension (SEP), or a SIMPLE IRA plan.

So - the partnership reports guaranteed payments and 401k contributions on K1 - and DEDUCT guaranteed payments on 1065;

The partner include guaranteed payments into his/her taxable income and will report the deduction for contribution on his/her tax return - form 1040 line 28.

Guaranteed payments will not affect capital accounts.

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Customer reply replied 2 months ago
with my example above, partner no 2 ends up with a negative 38,000 capital account. Since there is no debt, the capital account should be an approximation of his basis - but he can't have negative basis. So is $38,000 of the 401k contribution not allowed as a deduction - treat it as a suspended at-risk deduction? Or does the partnership need to make a reallocation of the net income of $38,000 so that Partner 2 has more income allocated so that the capital account isn't negative?
Customer reply replied 2 months ago
or should the 401k not have been allowed because the ordinary income was too low to support a contribution of $53,000?

Guaranteed payments will not affect capital accounts.

The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense.

Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services.

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Customer reply replied 2 months ago
i know that. I don't know why you are repeating that statement. Should the 401k contribution be included as a deduction on line 10 as part of guaranteed payments in the same way that health insurance is included in guaranteed payments?

That is correct - the partnership reports contributions to retirement plans on behalf of the partner as guaranteed payments.

That amount is DEDUCTED on 1065 line 10.
For the partner - it is reported on K1 and reported on 1040 as stated above.

Same tax treatment as for other guaranteed payments.

.

Regardless 401k plan contribution - the maximum allowed contribution for employer's portion is 25% of compensation.

We need to verify total amount subject to self-employment tax reported to each partner.

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Customer reply replied 2 months ago
do you have a citation for reporting retirement plan contributions on line 10 as part of guaranteed payments? the instructions to line 10 (form 1065) indicate that medical insurance should be included, but is silent to other items. It doesn't specifically reference retirement plan contributions.

See instructions for k1 - box 13 - Code R. Pensions and IRAs. - that is how that payment reported to the partner.

The problem which I see with the partner #2

Guaranteed payments 53,000 + other income 15,000 - so we may expect $68,000 on K1 box 14 under code A as self-employment income.
That effectively limits 401k contribution by $18,000 (employee elective deferral + $68,000 * 25% = $17,000 (employer's matching contribution.

Total allowed contribution is $35,000.

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Customer reply replied 2 months ago
The guaranteed payments to partner 2, BEFORE INCLUDING THE RETIREMENT PLAN, were $250,000.

Then - you do not have issue to make $53k 401k contribution.

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Customer reply replied 2 months ago
i think what you're saying is....
assume line 8 (total income) of the 1065 shows $800,000.
line 10 (guaranteed payments) shows $500,000
Line 22 (oridnary income) shows $300,000The K1 for partner 2 (5% owner) shows
line 1 (ordinary income) $15,000 ($300,000 x 5%)
Line 4 (guaranteed payments) $250,000
Line 13R (retirement) shows $53,000I think what you're saying is that
line 10 (guaranteed payments) should have shown: $500,000 PLUS total 401k for partners of $106,000 = $606,000
Line 22 (ordinary income) should have shown $800,000 minus $606,000 = 194,000on the k1:
line 1 should have shown $9700 (194,000 x 5%)
line 4 (guaranteed payment) should have shown $250,000 PLUS $53,000 = 303,000
line 13R (retirement) would have shown $53,000

We need to be clear that 401k contributions are made from two parts - employee elective deferral AND employer's matching contribution.

The issue is that the structure must be the same for all partners and all eligible employees.

It is possible to have ONLY employer's contributions.

If that what you choose - then you are correct - Line 13R (retirement) $53,000

Then - we need to have line 14A self-employment income - that includes both guaranteed payment and other business income.

The amount you report as guaranteed payment will be deducted for the partnership and will reduce other taxable income.

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Customer reply replied 2 months ago
I don't think you're really getting my question. Line 13R should be $53,000. For a partner in a partnership, employer contributions and employee deferrals are all treated as employee deferrals.My question is... what number should be included on line 4 of the 1065 as a guaranteed payment?
Customer reply replied 2 months ago
let's say, as a hypothetical, that there are two partners, and the only activity is the 401k plan. Just to isolate everything. The two partners own 95% and 5% of the partnership. Also, mathematically, the 401k contributions work out to be $25,000 to partner 1 (the 95% owner) and 50,000 to partner 2 (the 5% owner). Disregard whether this actually works.on the1065 line 10 (guaranteed payment) would be $75,000 which is the total 401k contribution made to the plan.
line 22 (ordinary income) would then be a loss of $75,000.Schedule K and K1 would show:
Sch K K1 K1
Partnership 95% partner 5% partner
Ordinary income..........................................-75,000........... -71,250...............-3,750
guaranteed payments................................. 75,000...............25,000...............50,000
line 13R.........................................................75,000..............25,000...............50,000
Customer reply replied 2 months ago
sorry, that should have looked like this:....................................................................Sch K................. K1 ....................K1
...............................................................Partnership........95% partner.......5% partner
Ordinary income..........................................-75,000........... -71,250...............-3,750
guaranteed payments................................. 75,000...............25,000...............50,000
line 13R.........................................................75,000..............25,000...............50,000

Your concern was - how a partnership "deducts" contributions to a partner's retirement plan.

The issue is that the partnership doesn't deduct such contribution.

Instead each partner deducts the contribution made by the partnership on his/her tax return - form 1040 line 28.
The partnership deduct that contribution as guaranteed payments AND report the amount of 401k contribution on K1 box 13R

In additional - on K1 box 14A reports self-employment income that is used to calculate the maximum allowed contribution.

.

The issue I see with your last numbers that ordinary income is negative - correct?
If so - that amount will reduce self-employment income on 14A and the partnership might over-contributed into 401k plan.

Lev
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Customer reply replied 2 months ago
if the partnership doesn't "deduct" the contribution, then it wouldn't be included in the guaranteed payments on the 1065, which is opposite of what you said earlier.I don't think you really understand this question.

Sorry for confusion...

But indeed deductions are reported on individual tax returns by each partner - form 1040 line 28.

The partnership deducts that amount as guaranteed payment - but reports these guaranteed payments on K1 box 4 as taxable to partners.

Sorry again.

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