What is Guaranteed Payments?

Partners are not employees of their partnership and generally cannot receive W-2 wages from it. When a partnership pays a partner a fixed amount for work or for the use of capital, without regard to the partnership's income, the payment is a guaranteed payment. The IRS explains them in Publication 541.

Tax treatment

• The partnership generally deducts guaranteed payments for services as a business expense, which reduces the income allocated among partners
• The partner reports guaranteed payments as ordinary income, shown on their Schedule K-1
• Guaranteed payments for services are generally subject to self-employment tax
• No income tax or FICA is withheld, so partners usually make estimated tax payments

Example

A two-member LLC taxed as a partnership pays one member $5,000 a month for managing operations, regardless of profit. Those $60,000 are guaranteed payments. Remaining profit is then allocated according to the operating agreement.

Guaranteed payments vs distributions

Distributions, or draws, are withdrawals of a partner's share of capital or profit and are not deductible by the partnership. Labeling matters: a fixed monthly payment for work is usually a guaranteed payment even if bookkept as a draw.

Health insurance

Health insurance premiums paid by the partnership for a partner are generally treated as guaranteed payments, which may let the partner claim the self-employed health insurance deduction.

In the books

Record guaranteed payments in their own expense account, by partner, separate from draws and from employee wages. See Form 1065 and capital account.

Related terms

• Schedule K-1: Schedule K-1 reports each owner's share of a partnership's or S corporation's income, deductions and credits.
• Capital Account: A capital account tracks each partner's or member's equity in a partnership or LLC.
• Ordinary and Necessary Expenses: Ordinary and necessary is the basic test a business expense must meet to be deductible.
• Self-Employment Tax: Self-employment tax is the Social Security and Medicare tax paid by people who work for themselves, calculated on net earnings from self-employment.

Browse more definitions in the small business glossary.