Dealing with the Partnership

The Code recognizes that a partner can engage in property, services, and loan transactions with the partnership in a capacity other than as a partner, i.e., as an independent, outside third party. The tax result, in general, is as if the transaction took place between two unrelated persons after arm's-length negotiations.

Customary Partner Services

• When a partner performs services for the partnership that are customarily performed by a partner, the partner's return is generally his or her share of profits of the partnership business.
  • A partner's allocable share of partnership items is the partner's "compensation" for acting to perform the normal functions of a partner, e.g., driving the truck and keeping books of an ice cream vending partnership.
    • It is gross income, not as compensation, but as a distributive share of partnership income.
    • The value of the services is not deductible by the partnership.
• A partner is not an employee of the partnership. There is no W-2, no withholding, and no FICA; the partner pays self-employment tax and makes estimated payments.

Guaranteed Payments

• A guaranteed payment (GP) is a payment to a partner for services rendered or capital used that is determined without regard to the income of the partnership. It is used to distinguish payments that are a function of partnership income and payments connected with partners acting in a nonpartner capacity.
  • Services. The services must be a customary function of a partner. They are normal activities of a partner in conducting partnership business.
  • Fixed amount stated. If the partnership agreement provides for a GP in a fixed amount, e.g., annual salary amount, the GP amount is the stated amount.
  • Use of capital. The payment may be stated to be interest on the partner's capital account or to be rent on contributed property.
  • Stated minimum amount. The partnership agreement may allocate a share of partnership income to the partner but guarantee payment of not less than a stated amount to the partner even if the allocable share is less.
    • If so, the GP amount is any excess of the guaranteed minimum amount over the distributive share allocable to the partner.

• • For purposes of determining the partner's gross income, the GP is treated as if made to a nonpartner.
    • The partner separately states the GP from any distributive share.
    • The payment is always ordinary income to the partner (compensation, interest, possibly rent).
    • The GP is reported in the recipient partner's tax year that includes the end of the partnership tax year (in which the GP was made or deducted by the partnership). A calendar-year partner receiving monthly payments from a March 31 fiscal-year partnership reports nothing until the year the partnership's year ends.
    • Receipt of the GP does not directly affect the partner's AB in his or her partnership interest.
  • For purposes of determining deductibility by the partnership, a GP is treated as if made to a nonpartner.
    • The payment is deductible if it would have been deductible if made to a nonpartner (or capitalized, if for a capital item).
    • If the GP exceeds the partnership's ordinary income, the resulting ordinary loss is allocated among the partners (including the partner who receives the GP).

• • For all other purposes, the GP is treated as if made to a partner in his or her capacity as a partner.
    • A partner is not an employee of the partnership.
    • The GP is self-employment income to the receiving partner.
    • added 2026 A GP is not qualified business income for the Sec. 199A deduction; the partner's distributive share is.
    • added 2026 Health insurance the partnership pays for a partner is a guaranteed payment, reported on the K-1, and the partner takes the self-employed health insurance deduction on the 1040.

Self-Employment Tax on Partners

• added 2026 A general partner's net earnings from self-employment include the distributive share of ordinary business income plus guaranteed payments for services. Rental income, interest, dividends, capital gains and Sec. 1231 gains passed through are not SE income. The 2026 Social Security wage base is $184,500.
• added 2026 Sec. 1402(a)(13) excludes a limited partner's distributive share (not guaranteed payments). Whether an LLC member who works in the business is a "limited partner" has been litigated for two decades: the Tax Court applies a functional test (Renkemeyer; Soroban, 161 T.C. 310 (2023); Denham and Soroban, T.C. Memo. 2025-52), and a working member is not a limited partner. The Fifth Circuit disagreed in Sirius Solutions (January 16, 2026), holding that state-law limited-partner status controls; appeals are pending elsewhere. At the desk: a working member of a Colorado LLC pays SE tax on the distributive share unless the facts clearly fit the exception.

Nonpartner Capacity

• Payments to a partner without regard to income of the partnership for property or for services not customarily performed by a partner are generally treated as if the transaction took place between two unrelated persons after arm's-length negotiations (Sec. 707(a)).
  • Loans. Interest paid to a partner on a (true) loan is all gross income to the partner and a deductible partnership item.
  • Services. Payments to the partner for services rendered (of a nature not normally performed by a partner) to or for the partnership are gross income to the partner and generally an ordinary deductible expense of the partnership.
  • Property. A partner acting as a nonpartner (independent third party, outsider) can sell (or exchange) property to (or with) the partnership and vice versa. Gain or loss on the transaction is recognized unless an exception applies. The partnership's loss on a sale to a partner is a partnership item allocated to all partners, unless the related-party rule disallows it.
  • Character and loss limit rules.
    • Applicability. These loss limits apply to any transaction between the partnership and either
      • A partner who owns more than 50% of the partnership (directly or constructively) or
      • Another partnership if more than 50% of the capital or profits interest of each is owned by the same persons.
    • Character. Any gain recognized is ordinary income if the property is held as other than a capital asset by the acquiring partner or partnership (Sec. 707(b)(2)); a capital asset sold to a more-than-50% partnership that will hold it as a depreciable asset produces ordinary gain to the partner.
    • Related party sales.
      • A loss on a sale between related parties is disallowed. The acquiring party has a cost basis, and a subsequent taxable disposition event results in no more gain recognition than any excess of realized gain over the loss previously disallowed; the seller never recovers the loss.
      • Expenditures are deductible when, and not before, the amount is includible in gross income by the payee, even if the payor is an accrual-method taxpayer.

• Interest on a loan used to buy a partnership interest is traced to the partnership's assets: 80% of the assets in an active trade or business means 80% of the interest is business interest.

The disposition of a partner's interest in a partnership may be accomplished by either a sale or a liquidation. Because the tax consequences differ between the two methods, it is important to understand the differences between them.

Private reference, not client advice. Original notes written 2022–2023 while studying for the SEE Part 2; figures updated October 2026 (Rev. Proc. 2025-32, Rev. Proc. 2026-15, P.L. 119-21). Verify current-year amounts before relying on them.