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IRS RULES ON IN-KIND PARTNERSHIP GUARANTEED PAYMENTS

June 04, 2007

Since the appearance of Limited Liability Companies, partnerships have become increasingly popular form for doing business. Multi-owner LLCs are normally taxed as partnerships, but they don't carry the possibilty of unlimited personal liability for business debts inherent in old-fashioned general and limited partnerships.

While there are many tax advantages to operating in partnership form, there are annoyances. One drawback that surprises many taxpayers is that if you work for a partnership you own, the tax law doesn't treat you as an "employee." Instead of having taxes withheld and getting a W-2 at year-end, you are supposed to pay your own quarterly estimated taxes, with your "salary" reported as a "guaranteed payment" on your partnership Schedule K-1.

One of the advantages of operating as a partnership is that partnerships, unlike either C corporations or S corporations, don't normally trigger taxable gain when they distribute property to their owners. Like so many useful parts of the tax law, the ability to distribute appreciated partnership property without triggering tax is subject to many restrictions.

The IRS underlined one of these restrictions Friday in Revenue Ruling 2007-40. The ruling says that if a partnership pays a guaranteed payment with appreciated property, the partnership is treated as having sold the property for its fair market value - resulting in taxable gain for the partners.

You can find a discussion of the issues addressed in this ruling in a 2004 Florida Tax Review paper, Guaranteed Payments Made in Kind By a Partnership, available via SSRN.

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