Joining forces with a colleague, friend, sister or spouse can allow you to build the business of your dreams.
As a Partner in a Partnership, you no longer just answer to yourself but now have additional responsibilities and roles that one of the Partners must fill.
Taxes, finances, operations, marketing? What hats do you wear?
Quickly, the finance Partner has the following question...
As a Partner in a Partnership, how do I pay myself and my Partners?
If you are an owner of a Partnership, it is critical that you understand the unique characteristics and differences to manage it effectively.
You have most likely figured out how to put assets and money INTO a partnership, but how do you take money out?
There is a right way and a wrong way.
If you are new to Partnerships, we cover this topic and other critical topics unique to Partnerships in our MasterClass on Partnerships, click here for more info.
How NOT to take money out of a Partnership
Partners are never paid via payroll. There is no W-2 and no 1099 issued to partners.
You can have employees in your Partnership that you have on payroll, but not Partnership owners.
This is due to how Partnerships are taxed.
Partnerships are disregarded entities - unless they elect to be taxed otherwise.
That means that the Partnership does not pay income taxes. That said, each state does require an annual franchise tax of sort, this varies by state and is not the same as income taxes.
Even though the Partnership does not pay income taxes, it is still required to file a Partnership tax return annually.
The Partnership tax return generates K-1 packages that are distributed to partner owners which enable the Partners to report their share of income and expenses on their own individual tax returns.
The income tax is paid on the individual tax return of partner owners.
How is cash paid out?
All payments from the Partnership to Partners are a form of cash transfer, whether you chose to transfer the money via check, ACH, bill pay or Zelle.
The method does not matter, as long as it is going from the business Partnership bank account to a Partner or their personal bank account.
The method and type of distribution must be categorized as such, in your bookkeeping software.
Otherwise, if one partner prefers checks and the other prefers Zelle, you can send money based on Partner preferences.
It is important to note that NO tax is withheld on payments. As such, tax planning is key, and estimated quarterly tax payments are highly encouraged.
3 ways to take money out of a Partnership
There are 3 ways to pay partners in a Partnership. Again, this is unique to Partnerships and does not apply S-Corporations or Single Member LLCs.
Note that loans can also be a method for withdrawing money from a Partnership but these fall in their own category and are not covered here.
- Distributions
- Guaranteed Payments
- Partner Reimbursements
Distributions
Distributions are simply a transfer of cash from the business bank account to partner accounts.
The RULE with distributions is that they must follow partner profit-sharing percentages.
So if you have two - 50% equal partners, distributions must be equal to each partner.
The discretion of timing and amount of distributions is that of management.
Guaranteed Payments
Guaranteed payments are recurring payments to select partner(s) for services performed.
These can be lopsided if you will, as participation in the business may also fall more heavily on one partner than on others.
As such, Guaranteed Payments do not need to follow profit-sharing percentages.
Guaranteed Payments are paid out in the same way, via ACH, check, bank transfer, etc., but are typically paid on a schedule to specific partner(s).
Partner Reimbursements
Early on in Partnerships, prior to business bank accounts and credit cards being established, it is common for Partners to pay for business expenses out-of-pocket.
Partners have a few choices on how this is handled, either way it is key that they track the expenses paid.
Partners can report out-of-pocket expenses as Partner contributions and add them to their investment in their Partner equity account (and not be reimbursed)
or
Partners can submit an expense report and have the business reimburse them for these out-of-pocket expenses.
In either choice, the business gets the benefit of the expense as a tax deduction.
In neither instance is the reimbursement or the increase in Partner Equity a form of taxable income.
After business bank accounts and credit cards are established, expense reports and reimbursements shouldn’t be common as business costs should be paid directly by the Partnership.
Partnership Success
Understanding the unique characteristics and how to manage the funds, report on taxes, pay partners, etc is an expectation of Partner owners.
If you need help setting up your bookkeeping with Partnership specific accounts, we are here to help.
Note that each type of transaction mentioned above needs it own account for tracking. Guaranteed Payments, distributions and reimbursements need to be tracked by partner in your bookkeeping software.
If you would like to be setup for success from the start, click here join our MasterClass for Partnerships.
