Determining Income for Partners

[Dan]

We have a client that operates as a partnership. They asked us to calculate maximum contribution for 1998. They indicated that all four partners should share equally regarding wages for the common law employees. But the K-1 compensation is vastly different for each partner and indicates that partnership percentages are various.

I am not an accountant, but this arrangement seems questionable. Is this arrangement strange or normal?

[Guest RS Vatalaro]

The partnership income allocation percentages can be in any variation the partners wish, as long as total partnership percentages = 100% and are in writing.

My understanding of determining partner income for allocation purposes is that each partner's K-1 (the tax reporting form showing each partner's pro rata share of income and expense) will show each partner's income from self employment (partnership income for active partners is subject to the self employment tax) and that, adjusted by 1/2 the self employment tax would be his /her "wages."

Guaranteed payments may factor into this issue as well. Guaranteed payments are usually cash distributions to partners, and also subject to self employment tax.

It might be a good idea to ask this company for their K-1 forms so that you can see exactly what was allocated to each partner, this should answer your question.

Hope this helps.

[Guest FredReilly]

I just finished a valuation for a partnership client and I base the earned income calculation on the partnership percentages. Generally all items of income and expense are allocated on that percentage and the IRS takes the position that specific allocations not based on a business necessity are invalid. I would check the K-1's to see what basis other expenses are allocated upon. Also, perhaps the partnership agreement may call for such an allocation. You may want the client to verify that.