Partner's "Pay"

[Guest Grumpy456]

The law firm of Smith & Wesson consists of two equity partners (Smith and Wesson--each 50% equity partners). Smith and Wesson are also each 50% profits partners. The firm also pays two lawyers as common law employees (W-2) and two lawyers as "partners" (K-1). There are, of course, a couple of support staff too.

The two lawyers treated as partners are paid via K-1 because what they get paid is based directly on what they generate. My question is whether someone can properly be a partner if they have no equity and no profits interest in the partnership?

[masteff]

A review of web articles reveals that "non-equity partners" are becoming increasingly common in law firms.

Page 6 of this article describes your basic scenario of a non-equity partner receiving guaranteed payment for services rendered to the partnership which are then reported on Sch K-1.

[Guest Grumpy456]

Thanks, that was very helpful.

Assume an individual receives a K-1 only for guaranteed payments ($100,000) and is entitled to a 3% of pay safe harbor 401(k) contribution. Does she get $3,000 ($100,000 times 3%) or $2,913 ($100,000 times 2.91262%)?

[Mike Preston]

Trick question? Or are you assuming that this individual had a W-2 for the SSWB from another employer? K-1 income is earned income. As such, you reduce it by the 1/2 FICA reduction, don't you? And, yes, you further reduce it by the deferral, I believe, so the non-integral percentage was closer to right than the 3%. Or did you factor in the 1/2 FICA reduction?

[Guest Grumpy456]

Good point, Mike--the $100,000 would also need to be adjusted for the 1/2 SET, if it hadn't already been adjusted.

I have yet another question. Assume the partnership had income after all expenses except retirement plan contributions and the K-1 guaranteed payments of $700,000. Further assume that there are 3 partners--P1 has a 50% equity & 50% profits interest in the firm; P2 also has a 50% equity and 50% profits interest in the firm; P3 has neither an equity nor a profits interest--he is just paid via a K-1.

Sal Tripodi writes in his ERISA Outline Book (see page 1.130 of 2004 edition) that "guaranteed payments are treated as part of the partner’s distributable share of partnership income." If P1 and P2 take guaranteed payments of $300,000 each that leaves $100,000 in firm revenue. P3 is paid guaranteed payments of $80,000. The remaining $20,000 will be allocated as a profit sharing contribution.

Is P3 an HCE by virtue of ownership? If, as Sal Tripodi claims, guaranteed payments are treated as part of a partner's distributable share of partnership income, then P1 and P2 are each 5% owners since they each received roughly 43% of the firm's income ($300,000 each divided by $700,000--ignore the retirement plan contribution). Is P3 an HCE too? P3 received roughly 11.5% of the firm's income despite the fact he has neither an equity interest nor a profits interest in the firm. Since 11.5% is "more than 5%", is P3 a 5% owner too?

Thanks in advance for any suggestions/help.

[Mike Preston]

I treat non-equity partners as HCE's in the vast majority of cases. Of course, usually their compensation is alone enough to ensure they are HCE's. But in that rare case where the compensation would be beneath the threshold you do the calculation you mentioned and if it is greater than 5% then they are an HCE. At least, that is the way that I *think* I've been doing it.

[Guest Grumpy456]

Thanks, Mike. That helps a lot.

[tghooper]

Follow up to this old thread...

Assuming that the guaranteed payments for the non-equity partners is well below the compensation limit, I would contend that they're still an HCE because of the fact that he/she files a Schedule C, in which they're 100% owner.  

Any disagreements?

[jpod]

I disagree, at least based on how I am interpreting your post.  If they are partners in a partnership they do not file Schedule Cs.  If their comp from the partnership is not sufficient to make them HCEs automatically they may or may not be HCEs depending upon their interests in the capital of the partnership.  Presumably as "non-equity" partners they have no interest in the profits of the partnership.  

[tghooper]

Yes, non-equity partners do not have interest in profits/capital.  The guaranteed payments flows to a Schedule C, which is an adopting employer of the plan...i.e. they're 100% owner of an adopting employer. 

[jpod]

In that case they are handling their taxes incorrectly.  There should be NO schedule c.  And, are you sure they don't have a capital interest in the partnership?  Absent a capital interest or a profits interest it is unlikely they should/can be treated as partners for tax purposes. 

[tghooper]

Correct...no capital interest.  Yes, seems that the accountant is not giving us the correct data or not doing it correct.  Thanks 

[jpod]

The account definitely said "Schedule C," not "K-1."  Is this in writing?  Maybe in the heat of battle (we are approaching April 15!) he said Schedule C when he meant K-1. 

[tghooper]

Accountant confirmed...Schedule C and not k-1..ie not a "partner".  Thanks Jpod

[tghooper]

Another scenario...why do accountants make this so difficult!?

Two partners in a partnership receive both W-2 wages and K-1 income.  Both had $10,000 each in 401k withheld from W-2 and $7,000 in SE income from K-1.  They said they wanted to maximize contributions to $24,500.  My contention is that they wouldn't be able to do this unless they went back and "corrected" the W-2 because the SE income is insufficient.  Also, any profit sharing would reduce SE income even further.  (I know...they shouldn't be receiving W-2 from the partnership)

Thoughts?