Allocation of Net Income
Revenues - Expenses = Net income
If total revenues exceed total expenses of the period, the excess is the net income of the partnership for the period. If expenses exceed revenues of the period, the excess is a net loss of the partnership for the period.
Management fees, Salary and interest allowances are guaranteed payments. The partnership generally deducts guaranteed payments on line 10 of Form 1065 as business expenses.
If partners pay themselves high salaries, net income will be low, but it does not matter for tax purposes. Partner compensation and allocated net income are considered ordinary income for tax purposes and as such are reported on the form 1040. It does not matter whether or not a partner withdrew any amount of money from his capital account. It's the net income, allocated to the partner, and his compensation from the partnership that are taxed, not the amount withdrawn.
Net income or loss is allocated to the partners in accordance with the partnership agreement. In the absence of any agreement between partners, profits and losses must be shared equally regardless of the ratio of the partners' investments. If the partnership agreement specifies how profits are to be shared, losses must be shared on the same basis as profits. Net income does not includes gains or losses from the partnership investment.
Read more about this topic: Partnership Accounting
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