Form 1065, page 4, Sched K, Line 14a

[RB287a]

(Note: Just to be clear, within Form 1065, the Schedule K and Schedule K-1 are different forms, not the same)
We have an 2 member LLC that used to own Rental Property but sold the property and carried the Loan Note in the LLC. After selling, usually only income is interest on Note. Our LLC splits profit loss 50/50 and I tell (TT for Business) this on my form 1065 each yr.
And TT rightfully splits our Interest income 50/50 to each our Schedule K-1s in box 5. This passes through to each our 1040's, we pay income tax on the Loan Interest but not SE tax since the interest is Passive income.
Now not always but some yrs the Property Owners business has cash flow issues and the sales contract denotes charges for late payment fees to compensate for my time with collections, bad checks, etc. This creates Ordinary Income which must be taxed also on SE tax.
The other LLC member is a Limited Partner in that he does not actively participate in the running of the business. I do all that and tell TT that I am a Managing Partner and he is a Limited Partner. Ok so far.
But here's the catch, Form 1065, page 4, aka Schedule K, on Line 14a, is supposed to be the sum of Self-Employment earnings for all partners subject to SE income under those tax rules.
The IRS Law reads only General Partners or LLC Active Member Managers (MMGR) are subject to SE tax for all Ordinary income & guaranteed pmts. Whereas Limited Partners are subject SE tax only on guaranteed payments (since as Limited Partners they aren't eligible for Ordinary income).
Now TT will attempt to get this right, since other member is designated a Limited Partner, TT will leave his Schedule K-1 box 14 blank. But in my Schedule K-1 box 14 it puts only 50% of the total Ordinary Income (aka SE Income).
Now I understand that TT is told we are 50/50 Profit Loss between the 2 members. But it would appear to me that the IRS wants all of it's SE tax not just 50% of it. So to work around this I pay myself the other 50% in guaranteed Payments to get the correct amount in my Schedule K-1 box 14.
It seems to me that TT for Business should put 100% of the Self Employment earnings in my Schedule K-1 box 14 without me having to do the guaranteed pmts. Appreciate any input on this.

[Rick19744]

Based on your facts, without your attempted corrections, TT is handling this correctly.

• Line 14 on each K-1 is only applicable for the income that is subject to SE tax specifically for that member
• Line 14 does not need to total 100% if 100% of the income is not subject to SE tax
• You do not need to force TT to do anything else.  Eliminate your guaranteed payment unless you are actually getting a guaranteed payment.

[RB287a]

Thanks for the reply Rick, but I still need this clarified further. Forgive me if I did not make this facet clear, but the reason I refer to it as 100% of the SE tax is because I (the Managing Member) am keeping or receiving all (100%) of said ordinary (SE taxable) income. So why wouldn't I be subject to all the income being taxed for SE? (unless the amount was over the SE threshold which is not the case here)  Please elaborate further.

[Rick19744]

I am not sure you understand how partnership tax works.

1. You indicate that this is a 50/50 partnership.  That means all income, loss, separately stated items are allocated between the members 50/50.
2. A guaranteed payment is an amount that is "paid" to a member regardless of what the bottom line is.  As an example: if member A receives a $10,000 guaranteed payment, this will be reflected on line 4a of the member's K-1 and line 14 regardless of whether the LLC had any income.  It would be reflected there even if the LLC incurred a loss.  This guaranteed payment is essentially "wages" to the member except not reported on a W-2.
3. Sch K would reflect this same $10,000 amount.
4. Line 1 of the K-1 reflects the ordinary income of the LLC and will be allocated in accordance with your 50/50 split.  This occurs regardless of whether a member is a managing member or limited member.  The only difference is the managing member's portion will be subject to SE Tax.  The limited member's portion will not be subject to SE Tax.
5. You now indicate that you are "keeping 100% of said ordinary income...".  This is not a 50/50 partnership then.  An allocation of anything other than 50/50 will require you understand and follow the very complex substantial economic effect regulations.

[RB287a]

Thanks for the reply and I do appreciate the help. [-Please read Edit Update at bottom first-]

I agree with everything up to your 3 last sentences. So lets zero in on those sentences and how I could find another option. If I cannot use guaranteed pmts to pass through sporadic Ordinary Income to the partner that earns said income, then what other method in the IRS rules can I use? I've looked at the Draw and it doesn't fit my scenario either.
Or in essence how would I tell TT to setup the profit/loss structure and Profit Allocation agreements to accommodate such, but hopefully hold to 50/50 for the interest income (or loss if the pmts defaulted or stopped)?
To reiterate scenario, I and my Limited Partner (who does not actively participate in management) each previously owned 50% of the property. We sold the property to new owners and loaned them the principal, and all interest paid each yr on the principal is split 50/50 between us and K-1 passed to each and taxed as passive income on our personal 1040. Normally that's all there is too it.
Only once in awhile the owners cost me (not my limited Partner) extra time and effort to deal with their late monthly pmt or failure to pay their property taxes etc. The amount of said late fees has never been over $500 and usually less than that depending. The Limited Partner is fully aware of these fees that reflect regulations of the sales contract. And he agrees that I should keep all said fees to compensate me for work in these matters.
How can I channel the compensating Ordinary Income paid in these sporadic occurrences to me for having had to deal with it? And have all due SE taxable income shown on the receiving member's K-1.

[ Edit update 5 mins later],

Or maybe I should be understanding (correct if wrong) that each time this scenario occurs, I need to pay myself a guaranteed Payment for the full amount of said Ordinary Income for these matters. And that will subtract the amount of the Ordinary Income from the LLC total Profits and put Profits back to the normal profits to go 50/50 (i.e. the interest pmts). And would also put all SE taxable income in my K-1.

[AliciaP1]

Your edited response/statement is correct!  When you pay yourself a guaranteed payment of the ordinary income you are handling the work for, you have now initiated the SE tax situation you were speaking about in your first post.  It also reserves the rest of the income to be split appropriately based on your ownership.

[Rick19744]

I disagree with @AliciaP1 .

As stated previously, a guaranteed payment is determined in advance of any activity and is paid out regardless of whether there is a loss or income.

You don't pay out a guaranteed payment at the end of the year based on what the bottom line is.

Doing so and winning the IRS audit lottery will not result in a favorable audit.  Plus, you don't take a tax position assuming that you don't get audited.  

You don't want to have results that don't comply with how your LLC is set up.  

I also explained that what you want to do must comply with very complex Section 704(b) regulations that deal with substantial economic effect.  These regulations are lengthy and require numerous calculations to determine if your desired allocation comply with the regulations.

If you want to allocate income differently than 50/50, then you need to find a tax professional who can work through your desired result.

I am sure the $$ we are talking about is most likely not worth the effort of doing anything other than the 50/50 split.

As it stands now, anything other than allocating 50/50, will not be correct.  You have a contract for the sold property and late fees are a part of that contract. Late fees generated by the LLC are part of the income of the LLC and should be allocated accordingly.

Individuals set up LLC's without understanding the complex nature of the entity structure and expect results different than what the tax law provides.  This happens because they don't discuss the matter with a tax professional in advance and then attempt to scramble when things don't go the way they want.  Unfortunately, sometimes they can't be fixed to the desired result.

[RB287a]

To be clear in reference to my Original Post question of why TT handled the K-1 as I described therein, that has been been answered, in that TT follows the Profit Loss percentage and it's up to me to determine how to disperse any other income that doesn't fit. So I have been educated to that premise and I am appreciative of that.

But I would also like to add more since at the end of my original question I said Appreciate any input on this. At this point the thread has become more a discussion. Of which I am grateful for the subject logistics and how I might (or might not) mitigate my dilemma of compensation for services performed. It appears I've been enlightened two directions.
(1) I'm not allowed to do it with Guaranteed Pmts.
and
(2) I would need to pay myself 100% of the Ordinary Income not 50% in order to make the SE tax correct.

It appears I have entered an area that doesn't have any clear cut avenues of mitigation.
So I checked with my Lawyer that set up our LLC Operating Agreement that does in fact cover compensating the managing member for such happenstance. But it doesn't designate what vehicle I can use to do this. My reading of the rules led me to use Guaranteed Pmts as my best choice. Of which I've have done a few times in yrs past just make sure the IRS got it's full SE tax in my Sched K-1 box 14.

So I also called a CPA of whom is a long time family friend that has handled several issues in the past for members of my family. I definitely owe him lunch for the conversation we had on this. These are my notes on that conversation,
---Begin notes with CPA
In past history the IRS and courts cannot always agree on how to define guaranteed payments, making it quite hard for everyone involved to determine the right way to deal with these payments.
Occasionally certain types of Partnerships and LLC agreements will sometimes allow members to distribute assets to a member or members disproportionately to Profit Loss percentages if it's agreed on in the LLC's Operating Agreement (including Amendments thereof). But with S Corporations disproportionate distributions are strictly prohibited and can "bust" the company S election wherein any taxes would be levied at the entity level rather than shareholder level. Since LLCs are a pass-through for taxes it's a different scenario.
With LLCs much of this hinges on the LLC's Operating Agreement delineation. The IRS defines Guaranteed Pmts as those made by a partnership to a partner for services without regard to the income of the partnership. Payments meeting this definition can also be made to a person who is not a partner. For a partner, the payments are ordinary income. For the partnership, these payments are deductible under IRC Sec. 162 (relating to ordinary or necessary business expenses) or capitalized under IRC Sec. 263.
---end notes with CPA.
My summation is there appears to be a bit of tunnel vision in the vehicles available to me to mitigate a simple thing as payment for services rendered without breaking the overall LLC agreement of profit/loss sharing. I only know that our only profits designated in our Operating Agreement are for 50/50 on any Interest pmts and 50/50 on any losses of said Interest and/or Principal pmts on the loan the LLC holds.
Any other ramifications of services to be rendered are to be paid to the member that services are performed by. And further if such member performed any services to an extent that he could no longer be designated as a Limited Partner, then his designation thereof would have to be changed to a Managing Partner. But that facet is academic to the need of a vehicle to pay a member for services rendered outside of the main premise of the LLC profits.
So at this point it appears to me the LLC's Guaranteed Pmts effectively mitigates my simple compensation for services rendered when they are needed. And it does so more simply and effectively than any other method I can find. Especially since this is not a mountain issue within our LLC, nor is it an often occurrence, or a large sum of money or tax owed.
I have always endeavored to pay all my taxes to the IRS and have never entertained any facet of not paying what I would owe. So if I do ever get audited I know the IRS has it's gotten all it's money due and all LLC members are in agreement with our Operating Agreement, and we can all go from there.
It was just a question of why TT handles it like it does, which was answered most effectively and welcomed input thereof. And I thank all the replies for you have given what I needed to decipher my original question and more.