Our LLC pays each partner guaranteed payments. Some of the GPs for services are for business activity and some are for rental activity. Of course, the TurboTax for Business GP entry page provides two boxes for me to separate the GPs by activity type. Some of our GPs for each type of activity are true expenses, while some belong in capital accounts. For the rental activity, this is not a problem as TT does not automatically deduct the GPs. So, I can enter the GPs that are expenses under each property (and more or less ignore capitalized GPs for rental activity).
However, TT automatically includes all business activity GPs as a deduction on Form 1065, pg. 1, line 10. How can I deduct only the business GPs that should be deducted (not including capitalized GPs) but include all business activity GPs (including capitalized GPs) on Schedule K?
You might very well have to resort to entry in Forms Mode.
I will also page @Rick19744 since you have two different types of activities.
I guess I need some more facts as I'm not real clear on the end goal:
The business activity is flipping houses. The partner receives guaranteed payments for his construction services, which are part of our basis/investment in each property.
@vbwilks wrote:
The business activity is flipping houses. The partner receives guaranteed payments for his construction services, which are part of our basis/investment in each property.
That is easily understood but it still does not address the following bullet point posted by @Rick19744:
Let me try to explain again as that is the only bullet point I was attempting to address.
If my partner provides labor working on 123 Pine St., then we capitalize his labor as part of our basis in 123 Pine St. We would not effectively get to deduct that cost until the year in which we sell 123 Pine St.
While we wait for @Rick19744 to respond, note two bullet points in his post, which stated, Guaranteed payments do not impact the capital account of a partner / member and GPs are always ordinary income to the respective partner / member.
Hence, the conclusion I draw from @Rick19744's post, as well as the law and Regs, is that capitalizing guaranteed payments for services rendered by a partner is not the proper tax treatment.
Quite frankly, I am not a tax professional and it may not be correct. However, as I understand proper treatment:
Because it is regular income to the partner, it needs to show up on Schedule K. Because the business should treat it as a capital expense deductible upon sale of the asset, it should not show up on pg. 1. This is the precise problem I am struggling with.
I feel certain that some guaranteed payments for business activity should be capitalized. Pub. 541 addresses organizational costs: "Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. Generally, organizational and syndication expenses are not deductible by the partnership...Organizational expenses and syndication expenses paid to partners must be reported on the partners' Schedules K-1 as guaranteed payments.
Thanks for the additional details.
The issue with the guaranteed payment(s) is no different than a business start-up paying out wages and issuing W-2's. In both cases, the respective individual will recognize ordinary income at the time of payment.
In the business start-up situation, while the employees will be issued W-2's and report that income on their respective 1040, the amount will not be deductible by the company until the business actually starts. Those cost will be accumulated and then amortized under Section 195.
The guaranteed payments are exactly the same; there are two components, (1) the payment of the guaranteed payment to the partner (member), AND, (2) the timing of the deduction for the business.
In both examples the company will need a book-to-tax adjustment (M-1) to adjust for this.
In both cases you will have an M-1 on the tax return for expenses on the books not on the return.
This won't impact the payment of the guaranteed payment to the member, just as it doesn't impact the wages paid to an employee of a start-up. Both recognize ordinary income when paid.
In your example, you will need to generate an M-1 as follows:
Dr. Construction-in-Progress
Cr. Guaranteed payments
This will adjust for the capitalization of the guaranteed payment you are referring to. It doesn't change the actual amount of guaranteed payment to the member, it just adjusts to arrive at the correct bottom line.
Then when the house is sold you will need to adjust the guaranteed payment (with a debit) to arrive at the result that matches the guaranteed payment paid out to the member. This entry then addresses the timing of the deduction to the company for the tax return.
As noted previously, guaranteed payments are paid out regardless of the income / loss of the business. The payment and timing of the deduction are separate.
Thanks very much for considering this issue. Can you suggest the best way to handle that in TT?
Since I am not in a Windows environment, I don't have access to the Business software (thankfully).
I am sure that @Anonymous_ can provide assistance on how to accomplish the journal entry in TT to arrive at the correct bottom line.
Yes, this is (clearly) going to require entering Forms Mode and, more than likely, one or more overrides.
This scenario is somewhat beyond the capability of the program in Step-by-Step Mode.
@Anonymous_ does the TT Business software allow for making an M-1?
While it may not adjust as noted in my prior response, can a preparer just go directly into the M-1 section and include an amount on line 4 of the M-1 section?
If that is possible, then the OP will just need to do the reverse once the house is sold.
While it may not agree to the actual books and records, it arrives at the correct tax result.
Yes, in direct response to your question.
In Forms Mode, there is an M-1 worksheet and the program allows direct entry on Schedule M-1.
Ok. Then for @vbwilks you will need to go into forms mode M-1 section and locate the line 4 (expenses on books not on return) and enter the amount you believe should be capitalized.
This only applies if the sale of a house straddles the tax years for when guaranteed payments are made.
Then the following year, when the house is sold, you will once again need to go into the forms mode M-1 section and enter the same amount as prior year except on line 7 (expenses on the return not on books).
Thanks very much for y'all's help on this. @Rick19744 @Anonymous_
I don't like doing overrides, but it does seem like this is something that just has to be accomplished manually.
@Rick19744 wrote:
I don't believe including an M-1 is an override.
No, it is not. You are correct.
Y'all are, of course, correct that an M-1 entry wouldn't be an override. In my head, I think I was worried about doing the M-1 entries for some reason and was thinking an override would be simpler. And it may still have required an override if done that way because there is already a Guaranteed Payments entry on M-1.
Alas, I believe I have found an even more elegant solution, which I shall explain here for posterity:
One important note: TurboTax backtracked and put my total from this box back into the Rental Activity GPs line on the Step-by-Step GPs screen, but this should not have any negative effect on your return as best I can tell. So, you could enter all GPs except deductible business activity GPs under rental activity on the step-by-step screen. But I think you would still want to add the supporting details on line 4a of the Schedule K form.
The guaranteed payment M-1 is not really an M-1. It is there to get the return to balance correctly since the guaranteed payments are a separately stated item.
I can't comment on your methodology since I cannot see the return or the expected results.
In my mind, unless you have an M-1 as noted in my previous response, the return is most likely not correct.
Having a red box in TT as you mentioned tells me your methodology is not correct.
It is no longer red after my fix. And I think perhaps your method could get it there as well. But my solution has the benefit of making M-1 line 3 correct, whereas before it showed the sum of deductible business activity GPs plus rental activity GPs but excluded capitalized business GPs.
I am likely getting into areas of accounting that are (way) over my pay grade, but I felt like an M-1 adjustment should reflect a disparity between books and return, and there isn't really a disparity. But perhaps you are correct and the IRS would rather see all GPs not deducted somewhere in M-1 (for both business and rental activity).
line 10 on page 1 is supposed to exclude capitalized guaranteed payments. schedule k line 4, k-1 line 4 and m-1 line 3 are supposed to report total guaranteed payments. so the only way to balance the m-1 is to use line 7 to report the capitalized guaranteed payments.
@Mike9241 wrote:line 10 on page 1 is supposed to exclude capitalized guaranteed payments. schedule k line 4, k-1 line 4 and m-1 line 3 are supposed to report total guaranteed payments.
That is all in line with my return.
@Mike9241 wrote:so the only way to balance the m-1 is to use line 7 to report the capitalized guaranteed payments.
My M-1 line 7 contains nothing, which I believe is correct because my M-1 line 9 correctly matches Analysis of Net Income line 1.
Another note after researching this:
M-2 line 3 instructions call for it to match Analysis of Net Income line 1. However, mine matches M-1 line 1 (income per books). TurboTax notes: If the net income per tax return shown on Schedule M-1 or M-3 does not reflect the net income (loss) used in maintaining the partners' tax basis capital accounts, the amount on Schedule M-2 must be adjusted to reflect the amount for tax basis capital accounts. The program will make the adjustments from the Schedule M-2, Line 3 Smart Worksheet. The adjusted amount will be used for Schedule K-1, Section L. All amounts on Schedule K-1, Section L, must now be computed using tax basis capital accounts.
i'm not sure how that can be
example page 1 sales $100,000
line 10 guaranteed payments $30,000
line 10 less capitalized $10,000 20,000
line 22 ordinary business income $ 80,000
schedule K
line 1 from page 1 line 22 $ 80,000
line 4a GP for services (capitalized) $ 10,000
line 4b GP for capital (expensed) $ 20,000
line 4c GP total $30,000
schedule m-1
line 1 net income per books $80,000 since $10K of GP were capitalized (unless you expense all GPs for books and only capitalize them, when needed, for tax)
line 3 guaranteed payments $30,000 total guaranteed payments are to be reported
line 9 would be $110,000 unless as stated above you expense all GPs for books.
line 9 is supposed to agree with net income per return - which is usually schedule K the sum of lines 1 through 11 and less the sum of lines 12 and 13