Do Guaranteed Payments Qualify for the QBI Deduction?

The Qualified Business Income (QBI) deduction, also known as the Section 199A deduction, was introduced by the Tax Cuts and Jobs Act of 2017. It allows eligible taxpayers to deduct up to 20% of their qualified business income from pass-through businesses. This provision is temporary and scheduled to expire for tax years beginning after December 31, 2025. For partners, this created questions about how different types of income are treated under these rules, especially guaranteed payments.

Guaranteed payments are defined as fixed payments made to a partner for services or the use of capital, calculated without regard to the partnership’s income. Because a partner receives the payment whether the business is profitable or not, it functions much like a salary. The interaction between these payments and the QBI deduction affects a partner’s individual tax liability.

The General Rule for Guaranteed Payments and QBI

For the partner receiving them, guaranteed payments for services rendered to the partnership are specifically not considered Qualified Business Income. This means a partner cannot include these specific payments in the calculation for the 20% deduction. This exclusion is based on the principle that guaranteed payments are treated as compensation for labor.

This is conceptually similar to the wages an employee receives, which are also excluded from QBI. The payment is viewed as compensation for a partner’s labor rather than a share of the profits generated by the business. The QBI deduction is intended to provide a benefit on the return from business risk and operations, not on what is effectively a salary.

A partner must report the full amount of the guaranteed payment as ordinary income, subject to income and self-employment taxes. When it comes time to calculate the QBI deduction, typically using Form 8995 or Form 8995-A, this income amount must be excluded from the base amount.

Partnership-Level Impact of Guaranteed Payments

While a guaranteed payment is not QBI for the recipient, it affects the partnership’s calculations. From the partnership’s perspective, a guaranteed payment made to a partner for services is treated as a deductible business expense. This payment reduces the partnership’s ordinary business income, similar to how it would deduct wages paid to an employee.

This accounting step directly impacts the amount of QBI that the partnership can pass through to all partners. The QBI calculation starts with the partnership’s net business income; because guaranteed payments are deducted, they lower this starting figure. This results in a smaller pool of qualified business income to be allocated among the partners according to their profit-sharing percentages.

For example, a partnership generates $200,000 in ordinary business income. It makes a $50,000 guaranteed payment to one partner for services. The partnership deducts this $50,000, which reduces its net ordinary income down to $150,000.

This reduced figure of $150,000 is the total QBI to be distributed. Each partner, including the recipient of the guaranteed payment, will receive their share of this $150,000 as their allocable QBI on Schedule K-1. The guaranteed payment therefore diminishes the QBI available for every partner.

Nuances and Special Considerations

Guaranteed Payments for the Use of Capital

Guaranteed payments can also be made to partners for the use of their capital. This occurs when a partner provides capital beyond their required contribution, and the partnership agreement specifies a fixed return. Much like payments for services, these guaranteed payments for the use of capital are also excluded from the definition of Qualified Business Income.

The reasoning for this exclusion is that the payments are not considered to be from the active conduct of a trade or business. Instead, the regulations treat this income as being more similar to portfolio income, such as interest earned on a loan. This interest-like return on capital does not qualify for the 20% deduction.

Distinguishing Distributive Share from Guaranteed Payments

A partner’s income often includes both a guaranteed payment and a distributive share of the partnership’s remaining profits. While the guaranteed payment portion is not QBI, the partner’s distributive share of the partnership’s ordinary income generally does qualify as QBI, assuming all other requirements are met.

Imagine a partner is entitled to a $50,000 guaranteed payment for their management role. After the partnership deducts this payment, its remaining net business income is $150,000. The partnership agreement states this partner also receives a 25% share of all remaining profits. The partner’s distributive share is therefore $37,500 ($150,000 x 25%).

On the partner’s Schedule K-1, the partnership will report the $50,000 as a guaranteed payment and the $37,500 as their share of ordinary business income. When this partner calculates their personal QBI deduction, only the $37,500 distributive share is included in the QBI amount. The $50,000 guaranteed payment is excluded from the QBI calculation.

Publicly Traded Partnerships (PTPs)

The rules for the QBI deduction related to Publicly Traded Partnerships (PTPs) require a separate calculation from other business income. Taxpayers must calculate their deduction for PTP income apart from their non-PTP business income.

Despite the separate calculation, the rule regarding guaranteed payments remains consistent. Any guaranteed payments a partner receives from a PTP for services are not considered qualified PTP income and are not eligible for the QBI deduction.