 Hello and welcome to this session in which we will discuss guaranteed payment in a partnership. In the prior session, we looked at form 1065 and we discussed what are separately and separately stated items. And within that discussion, I mentioned that we have this deduction here that's called a guaranteed payment that will merit a separate recording because it's a special type of a deduction on the partnership form on the 1065. Therefore, in this session, I'm going to go ahead and discuss what is a guaranteed payment. In other words, I am not ignoring the other component of the form 1065 income deduction. We also looked at other items such as a schedule K and schedule K1. But in this session, I'm going to be focusing specifically on guaranteed payment. So let's go ahead and get started. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. So what is a guaranteed payment? Well, from the word guaranteed payment, it's not based on your income. So you don't get a guaranteed payment. In other words, the partners or the members or the shareholder, whatever you want to call them, don't get the payment because the company means the partnership earned a certain amount of income. So it's not a percentage of income. It's not based on income. It's not influenced by how well or not well the partnership is doing. Now, you might be asking, so what is this guaranteed payment for? Well, this guaranteed payment is basically payment made to the partner, to the owner. Why? Well, think of it from A, an owner or a partner or a member perspective. If you are an owner, I mentioned the word owner, I say shareholder. But for a partnership, you're a partner or you're a member if it's an LLC. You are really self-employed. As a self-employed individual, you don't get wages. You don't get a W2. You don't get a 1099. You don't get those. But you need to live. Let's assume your only work is what? Is an owner in a partnership. And many people, that's what they do. They live of their business that they form with other people in a partnership. So they have to take some money out to live off that money. Well, it cannot be considered salaries and wages because notice here we have salaries and wages, but those are for people other than the owners, other than the partners. So the partners cannot get a W2. The partners don't get a 1099. So what they do is they get, they withdraw some money and they call it guaranteed payment. Now that money has to be basically for something. What is it for? Well, it's usually for services because, as I mentioned, this partner works for the partnership. They do the work for the partnership. Now, although it's for services, we cannot call it a salary. Remember, as a partner, you are, it's a bunch of self-employed people working together. Or it could be for capital investment. Let's assume you contributed money to a partnership, but you don't work for that partnership. We'll simply put you want to earn, in quote, some money on your investment. Therefore, what we do is we draft an agreement saying you are going to get a certain percentage of your capital, certain percentage of your capital or a fixed dollar amount. Regardless, this guaranteed payment will have to be basically, in a sense, put down written down because we have to know it's a guaranteed payment. And it's usually either for services, it means the partner is working for the business or it could be for capital contribution. It could be for both. You could be contributing capital. You want some, you want to earn some money on your capital and you are working at the same time. It doesn't have to be exclusive. It could be both. Okay. But that's basically what it is. Now, you have to keep in mind that this is a deduction, the 240,000. It's part of the deduction. In other words, there's no reason that it may not create a loss. So it could create a loss here. So the guaranteed payment could create a loss. That's fine. That's perfectly fine. You might be saying that if it's creating a loss, now we're avoiding to paying taxes on the partnership income. Yes, you're going to see what's going to happen. It reduces your ordinary income. It's an expense. It's a deduction on the form 1065. But you're going to see on the next slide, it gets picked up by the partner. So this 240,000, it's distributed to the various partners. So you might be saying, but it's creating a loss. We don't have to pay taxes. Yes, the partnership don't pay taxes anyway, the partnership itself, the 1065 don't pay taxes. So what's going to happen, this 240,000, it gets reported on schedule K with other ordinary income and separately stated item, and it gets picked up notice here 120 plus 120, it gets picked up by the partners. So in other words, the partnership takes a deduction. That's good. We reduce our ordinary income, we reduce our taxes as far as form 1065. But that's not how it ends. Then this whatever we used to reduce our income to a loss, let's assume it created a loss, it gets picked up as a separately stated item on the partner schedule K one. In other words, this is schedule K one. And for example, Adam is a partner in this partnership. Adam share is 40% of the of the what was the amount of the 240,000 of the 240,000. Adam's going to get 40% of that. Therefore, Adam will get 96,000 96,000, which is 48,000 for services, 48,000 for capital for capital contribution, we could just doesn't have to be 50 50, but we have we happen to to treat it that way. Now what is the character of this income? So when when Adam gets this schedule K one and sees $96,000 under tax return, well, simply put, if Adam is active member and this partner, it means active, actively working, then this is active self employment, it's ordinary income, that's fine. If it's not, it's then they would report this as passive income, it's then has special rules when we have a passive income. So it could be active income, it could be passive income, but nevertheless, it's considered ordinary income. Here's what you have to think of it. Box one, which is ordinary business income and box for a and for B, which is, you know, box for C, which is the guaranteed payment, those are in quote the pay for the partners. So the if the if the business makes a profit, ordinary income is reported to various partners, also the partners takes money out as guaranteed payment. And we explain what guaranteed payment, it's not W2 wages, it's not 10 99. It's to prove it's kind of it's a special type of payment. That's why we have a separate recording for it. So it's not salaries, it's not 10 99. It's called guaranteed payment. But this is how the partner will need to take money out basically to live. Now we could have distribution. This is not a distribution. This is not a withdrawal. This is called the guaranteed payment totally different because guaranteed payment. Remember, it's deductible, deductible, deductible on the 10 65 withdrawals and distribution are not. And it's treated as if it received the last day of the partnership tax year for tax purposes. That's fine. It's it's taxable for the whole year. Now, remember, guaranteed payment are deductible and sometime you take it out to pay your health insurance. That's also part of it. That's fine. That's deductible. It's not a distribution because distribution are not deductible. If you take a distribution, it's not a withdrawal that those affect your basis. They don't go anywhere on the 10 65. That's why the guaranteed payment is unique because it goes on 10 65 as a non separately stated items. It reduces your ordinary income, which is great. It's going to reduce our taxes. Then then then whatever your share is of that guaranteed income, it's get it gets allocated to you. Then you have to pay taxes on it. So it's really you pick it up. You deducted it on the 10 65, you pick it up on the schedule K one, then that goes on your 10 40 and you pay taxes on it. So it's not like, you know, you're getting, you're getting away with paying taxes. So this is what a guaranteed payment is. Remember, as a partner, you cannot get a W two because you're self employed. You know, remember, partnership is different than an S corporation. And you don't get a 10 99. Therefore, usually, usually the guaranteed payment, usually it's shutting down because if it's not written down, we would assume those withdrawals, those guaranteed payment, if it's not clearly stated, they may be considered distribution or withdrawal, which is totally different, which we'll have to talk about that later, a distribution from a partnership, totally different than a guaranteed payment. So I hope this session just illustrated or clarified this important, simple, important concept, which you could see on the CPA exam, you need to know for your partnership, you know, tax scores, what should you do now go to Farhat lectures, look at additional resources, lectures, multiple choice to false. Look at the notes that's going to help you understand this concept better. Invest in yourself. Good luck. Study hard. And of course, stay safe.