# Understanding Guaranteed Payments to Partners: Comprehensive Tax Guide

![Internal Revenue Code](https://www.investopedia.com/thmb/EezoM7lmxYZ57PlR3xq5vwmHJtY=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/internal-revenue-code-182170994-578e5dca3df78c09e936a95b.jpg)

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## What Are Guaranteed Payments to Partners?

Guaranteed payments to partners serve as compensation for services or capital provided, acting like a salary independent of partnership profits. These payments, outlined in Section 707(c) of the Internal Revenue Code, create specific tax implications. Without proper handling, these payments can lead to unexpected financial consequences for both partners and the partnership.

### Key Takeaways

*   Guaranteed payments are essentially salaries for partners in a partnership, made regardless of the partnership's profitability.
*   These payments are always considered ordinary income for the partner and can be a deductible expense for the partnership.
*   Mismanagement or improper structuring of guaranteed payments can lead to unexpected tax implications for both partners and the partnership.
*   Timing differences between the fiscal years of a partner and partnership can affect the reported income of the partner.
*   Guaranteed payments may be subject to special tax considerations in certain jurisdictions, especially for real estate partnerships.  
    

## How Do Guaranteed Payments to Partners Work?

Section 707(c) of the [IRC](https://www.investopedia.com/terms/i/internal-revenue-code.asp) defines guaranteed payments to partners as those for services or capital, made without depending on the partnership's income.

If these payments fit the definition, they're treated as given to a non-partner for tax purposes. Guaranteed payments to partners are always treated as [ordinary income](https://www.investopedia.com/terms/o/ordinaryincome.asp) for the partner. For the partnership, such payment is deductible under IRC Section 162 (as ordinary or necessary business expenses) or capitalized under IRC Section 263.

The concept of guaranteed payments to partners may seem pretty simple, but the details can make them complicated. Payments that have not been structured properly can lead to unexpected and expensive tax issues for both the partner receiving payment and the other partners.  

## Navigating Tax Implications of Guaranteed Payments to Partners

With regard to a partnership, it might have an agreement that a partner is to receive 20% of partnership income before any guaranteed payments happen, with a stipulation that they must receive at least $13,000. If partnership income is $100,000, the partner would get $20,000—none of which would be a guaranteed payment, so it could not be deducted by the partnership. However, if the partnership earned $30,000, then the partner would only get $6,000 as their share. As they are due a minimum of $13,000, the remaining $7,000 would be made in the form of a guaranteed payment and thus eligible for tax deduction by the partnership.

With regard to a partner, an ill-timed payment could increase their tax burden. Consider the timing issues under a scenario that has the partner using the [calendar year](https://www.investopedia.com/terms/c/calendaryear.asp) as their [fiscal year](https://www.investopedia.com/terms/f/fiscalyear.asp), while the partnership’s fiscal year ends on Sept. 30. If a partner were to receive a guaranteed payment after Sept. 30 but before Jan. 1, that income would have to be included in the partner’s following tax year, even though it occurred in the current year.

There are also special considerations that must be taken into account with guaranteed payments to partners and real estate, as local governments sometimes levy a tax on unincorporated businesses. For example, New York City, [which functions under a complicated New York State business tax code](https://www.investopedia.com/articles/personal-finance/102815/taxes-new-york-small-business-basics.asp), has its own unincorporated business tax (UBT) that applies to partnerships as well as [sole proprietorships](https://www.investopedia.com/terms/s/soleproprietorship.asp). While the tax burden can be significant, exempted from it is net income from renting and ownership of the rental real estate. Therefore, [real estate partnerships](https://www.investopedia.com/terms/r/realestatelimitedpartnership.asp) should consider the tax implications of any guaranteed payment to a partner.

When a real estate partnership makes a guaranteed retirement payment, it is treated as ordinary income for services, classifying it as [earned income](https://www.investopedia.com/terms/e/earnedincome.asp). As such, it is subject to [self-employment tax](https://www.investopedia.com/terms/s/selfemploymenttax.asp), which can be expensive. However, if it were characterized as a distributive share, it would not be subject to self-employment tax, thanks to the above-mentioned exemption.

## What Is the Purpose of Guaranteed Payments to Partners?

Guaranteed payments to partners are intended to compensate them for services made or the use of capital. They are made without any link to the partnership’s profitability and, indeed, represent a net loss to the partnership. In effect, they act as a salary for the partner, shielding partners from risk if the partnership is not successful.

## What Are the Tax Implications of Guaranteed Payments to Partners?

These can get rather complicated, but basically, a guaranteed payment to a partner is treated as ordinary income of the partner and taxed as such. The partnership can either take a guaranteed payment as a tax deduction or capitalize it.

## What If the Partnership’s Fiscal Year Is Different From the Partner’s?

This can lead to an unintended income increase for the partner, as guaranteed payments made after the end of a partnership’s fiscal year but before the end of the partner’s fiscal year would get counted as income in the partner’s following fiscal year, not the one in which it is actually made.

## The Bottom Line

Guaranteed payments to partners serve as compensation for their time, services, or use of capital, functioning much like a salary and providing financial security regardless of the partnership's success. By doing so, they create distinct tax considerations. To effectively manage these tax implications and avoid potential fines or burdens, both partners and partnerships must carefully structure the payments.

Understanding these nuances, including the potential impact of differing fiscal years and local taxation rules, is crucial for all parties involved.  

> **Article Sources**
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> 1.  Internal Revenue Service. “[Section 707.B—Transactions Between Partner and Partnership. 26 CFR 1.707-1: Transactions Between Partner and Partnership](https://www.irs.gov/pub/irs-drop/rr-07-40.pdf).”
>     
> 2.  Internal Revenue Service. “[Part I: Section 162.—Trade or Business Expense. 26 CFR 1.162-2: Traveling Expenses](https://www.irs.gov/pub/irs-drop/rr-99-7.pdf),” Page 1.
>     
> 3.  Internal Revenue Service. “[Part I: Section 263.—Capital Expenditures. 26 CFR 1.263(a)-1: Capital Expenditures; in General](https://www.irs.gov/pub/irs-drop/rr-00-07.pdf).”
>     
> 4.  New York State Society of CPAs: The CPA Journal. “[Our Greatest Hits | Avoiding Costly Mistakes on Guaranteed Payments to Partners](https://www.cpajournal.com/2017/09/01/greatest-hits-avoiding-costly-mistakes-guaranteed-payments-partners/).”
>     
> 5.  NYC Business. “[Unincorporated Business Tax (UBT)](https://www1.nyc.gov/nycbusiness/description/unincorporated-business-tax-ubt).”