Guaranteed payments are payments to partners

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Guaranteed payments are payments to partners determined without regard to the partnership’s ordinary income. Generally, they are deductible by the partnership as ordinary and necessary business expenses and must be reported as ordinary income by the receiving partners. Such payments may be provided for services rendered or for the use of capital. However, to be deductible a guaranteed payment cannot be a capital expenditure and must meet the tests as ordinary and necessary business expenses. pp. 21-36, 21-37, and Examples 40 to 42 11. The parties should address the following issues: Debt vs. Equity/Capital: Should Marcie loan the money to Sam, or should she become a permanent co-owner? If she loans money, at what interest rate and over what time period will she be repaid? If she contributes capital to a partnership or buys stock in a corporation, will she require a preferred return (e.g., through preferred stock or preferred cash flow distributions on her partnership interest)? Entity form: If the parties decide Marcie will become a permanent co-owner, should the entity be formed as a corporation or a partnership? If they decide to use the corporate form, will they operate as a C corporation or an S corporation? If they
21-10 2005 Comprehensive Volume/Solutions Manual decide to form a partnership, will they operate as a general or limited partnership, or as an LLP or LLC? This decision cannot be made until other issues described below are decided upon. pp. 21-2 and 21-3 Liability protection: Given the liability inherent in offering alcoholic beverages for sale to the public, how can the parties protect their personal assets? Both entity form and purchased insurance should be used to protect their assets. A C corporation, S corporation, or LLC could be used to shield both Sam’s and Marcie’s personal assets. Also, if a partnership is used, Marcie could be admitted as a limited partner to minimize her personal liability. Umbrella liability insurance coverage will further protect personal and business assets. p. 21-4 Flow through of losses: If the expansion is expected to produce tax losses for a few years, what is the best entity structure to use to ensure the losses flow through to the owners? Both a partnership or a Subchapter S corporation will allow losses to flow through to the partners or shareholders. p. 21-32 Interest for services: If Sam contributes 40% of the capital for 50% of the business, will he be deemed to receive an additional 10% ($250,000) of the business in exchange for services? Whether a C corporation or partnership is formed, compensation for services will be subject to current tax. Instructor Note: This tax could be minimized by having the parties make the initial contributions in proportion to the ultimate share of profits they will receive (e.g., Marcie would only contribute $1,000,000 on formation of the business). Any additional contributions could be made at a later date or could be loaned to the business with a specified payback rate and time frame. (Note that any additional contribution by Marcie could not be

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