Q: Where do Guaranteed Payments show on the personal income tax returns, e.g., wages on page 1 of Form 1040 or on Schedule E/Part II? What about officer compensation for a Subchapter S corporation?
A: Guaranteed Payments for partners in a partnership are reported on partners' Schedule E/Part II and then carried to Line 17 on Form 1040.
Officer compensation for officers of a Subchapter S corporation are included with Salaries and Wages on Schedule 1120S.
Q: Are Guaranteed Payments always included in wages on the accrual income statement?
A: Yes. As long as the accrual income statement is prepared according to GAAP, guaranteed payments are recorded as part of salaries and wages within operating expenses.
Q: If officers’ compensation is broken out on the accrual statement would this typically include guaranteed payments?
A: Yes. If officers’ compensation is broken out, and the partners in question were classified as officers, then their guaranteed payments would be included as part of officers’ compensation.
Q: What other expenses are not allowed to be deducted for tax basis purposes?
A: Examples of expenses that are not allowed to be deducted for tax purposes include the following: campaign contributions, gifts to employees or business associates greater than $25, certain community expenses, various amortization expenses and specific reorganization expenses. For a more comprehensive list, please consult the IRS guidelines.
Q: Why is the $375,000 in Guaranteed Payments shown as an adjustment on Schedule M-1 when it is included as an expense on both the tax return and the accrual financial statements?
A: The guaranteed payments must be reported on Schedule M-1in order to assure that partners pay taxes on both Ordinary Business Income reduced by Guaranteed Payments of $375,000 as well as pay taxes on $375,000 of Guaranteed Payments.
Note that Schedule M-1 includes both taxable partner revenue in the form of Ordinary Business Income AND Guaranteed Payments of $375,000.
Q: Is it correct to say if your client has CPA prepared tax returns that the CPA will then be able to provide year-end GAAP balance sheet and profit and loss statements, which would be better than a company prepared balance sheet and profit and loss statements, especially with less sophisticated clients?
A: In general, yes. A CPA must review and use accrual statements in order to complete the tax return. However, do not disregard company prepared financial statements as they can be of very good quality.
Q: From the perspective of the tax return, what is the objective of the Schedule M-1? In other words, why does the IRS want to see this information? The purpose does not appear to be that of allowing a mechanism for making adjustments to GAAP.
A: Taxpayers have different objectives when they prepare the financial statements and when they complete their tax return. The financial statements are prepared with an objective of maximizing income and thus increasing the net worth of the shareholders while maintaining conformity with GAAP.
The tax return is prepared with the objective of minimizing taxable income and, thus, reducing taxes paid, while maintaining compliance with tax law. The books and records of a corporation are kept in accordance with GAAP and not in accordance with tax law.
The result of these differing objectives can leave a large disparity between book income and taxable income. Schedule M-1 is the bridge (reconciliation) between the books and records of a corporation and its income tax return. The tax return is prepared after completing Schedule M-1 adjustments, and therefore understanding Schedule M-1 is a crucial part of the examination of a corporate income tax return.