Owner's pay out of equity

**emayland** · 04-29-2009 01:03 PM

I have recently began doing the bookeeping for a small partnership business and am in the midst of updated their bookeeping to QB premier accounting. I learned that when they get their paychecks that it should come out of the equity account for the business. My question - is their pay considered an expense of the company? Or is it because they are partners/owners that their pay is actually a draw on the equity? End result, is their pay someting that can be listed as an expense against the profit on the final profit and loss statement?

Any help with this topic would be greatly appreciated.

Thanks

**Pat** · 04-29-2009 10:21 PM

Payments to partners can be normal payroll expense or capital distributions or some combination of both. The owners or partnership agreement would have the answer. The prior payments should pretty much tell you which one it is. Have the prior payments had payroll tax deductions and been included in wage reports or just recorded as debits against capital.

You should always require client input forms to have a clear description of whats being paid (i.e. normal payroll, capital draw, inventory, equip, expense, etc..) You should never have to guess. You may have to decide the proper classification but only after receiving your clients input.

**Helse** · 04-30-2009 12:45 AM

Pat created a communicative block for me to seize a terse topic, ready for pain:
Wages, DNI or capital distributions?

True: Partnership agreement governs interpretation of distributions with respect to agreement
among partners.
I'll attempt to tackle tax ramifications with Pat on my heels guiding your ledger accounting with QB*.

Partners Salaries or Wages are not Distributable Net Income (DNI) from a partnership
(K-1 income).
"The prior payments should pretty much tell you which one it is." Problem:
Some ledger accountants denome partnership distributions as salary or wage because
Quickbooks lacks appropriate partnership classifications. In a perfect world QB options:
Partner Guaranteed Salary or Wage from Income
Partner Guaranteed Salary or Wage from Capital
Partner Income Distribution from Active Business
Partner Capital Distribution from Active Business
Partner Income Distribution from Investment
Partner Capital Distribution from Investment
Partner Draw From Partner or NonPartner Capital
Partner Draw From Partner or NonPartner Income
If partners consider "wages" distributions of monthly profit or draw from DNI and ledger accountant
created a wage account in QB because QB offers no other option then historical reference may misguide.
Significant FICA and SET ramifications result from Wage versus DNI classification for LLCs/LPs/LLPs.

Background: Partnerships and Guaranteed Payments, IRC sec 707(c)
Any distribution made to a partner, in his capacity as a partner, is dependent upon a distribution
from profits (DNI). Otherwise, distribution excluded from DNI. If the partnership net income = $5,000 in April, $5,000 DNI is available
for distribution. Beyond $5,000, the partner is receiving nonDNI.
Ergo, partner is either borrowing from the partnership or depleting capital reserves**. Here Pat may chime
foul, this is a 400 level accounting topic, answers debated at highest levels since Fibonacci invented banking
firma (firma = partnership) ledger mathematics in Venice Italy.

Tax aspects affecting ledger accounting:
1.) A partner receiving capital from reserves must, in excess of contribution, perform a "capital account
recontribution to eliminate excess draw to DNI.
2.) A partner receiving draws in excess of DNI or capital account (QB: paid in capital) must rectify a
draw exceeding partner's DNI with contribution to capital account***.

Example: ABC LLC: 2 service partners, active business
$10 per hour wage W-2
DNI: 50%-50%
Partner 1 services return $48,000 in excess of wage . Partner 1 Draw $4,000 p/mo. 0 Capital Account at Year End
Partner 2 services return $40,000 in excess of wage . Partner 2 Draw $4,000 p/mo. -$8,000 Capital Account at Year End

Partner 2 is required to perform a Capital Account Deficit contribution of $8,000

* Note to PAT, I am a professional practitioner of mediocrity in QB. 10 years experience at MediocrePro Certified.
** Exceptions to rule exist
*** Accounting literature is notoriously inept at distinguishing from ledger accounting capital accounts and tax capital (nonincome) accounts and income accounts. Oye, Confusing.

**Helse** · 04-30-2009 12:58 AM

"My question - is their pay considered an expense of the company?"

Answer:
Yes, if the partners receive 707(c) guaranteed payments
No, if the partners receive draws on annual partnership profits (DNI) mislabeled in QB as "Wages".

W-2 or K-1 distributions assist to determine historical intent of partners, as Pat noted.

Please, somebody inquire regarding the distinction between salary or wages for partners and DNI, the
partnership Holy Grail, free from FICA & SET (ref.: IRC 1402(a)(13)).

**Pat** · 04-30-2009 07:59 AM

You gotta love Helse as he not only presents advice but also backs it up with code sections. He is too kind as I'm just shooting from the hip with my experiences.

Taking advice backed by code section is a highly recommended approach. Tax is certainly a highly complex area where the code is King. As the facts dictate which code sections apply be sure to document them for any advisor. Unfortunately, for us mere mortals outside the tax area, we often learn that tax has its own unique language which can produce unexpected outcomes when interpretations differ.

By the way can we have more comments on the distinction between salary or wages for partners and DNI.

Good Luck,
Pat

**Helse** · 04-30-2009 10:45 PM

Distributable Net Income (DNI): Distribution of partnership profits from active or passive net income.
Exempt from FICA
Exempt from SET for Limited Partners and LLC NonManaging Members

Distribution of partnership profits is determined by partnership agreement. Partners request for "draws" are either
loan from partnership capital or premature distributions from DNI. Example: auto dealership salesperson requests
a $500 draw from monthly commission account valued at $700. Draw = DNI distribution.

Guaranteed Payment:

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