Decoding 1065 Guaranteed Payment vs. 1120S Distribution: What's the Tax Difference?

The main difference comes down to how each is taxed and when. In a partnership (Form 1065), guaranteed payments are similar to a salary paid to partners regardless of partnership profits. These payments are deductible by the partnership but are subject to self-employment tax (15.3%) for the recipient partner. With an S-Corporation (Form 1120S), distributions represent a share of profits that aren't subject to self-employment tax. However, if you're an owner-employee of the S-Corp, you need to pay yourself a "reasonable salary" first (which is subject to employment taxes) before taking distributions. The big tax advantage with S-Corps is that those distributions don't face self-employment tax, while ALL guaranteed payments to partners are subject to it. This is why many consultants eventually choose the S-Corp route when their income reaches a certain level.

I was really confused about this same thing last year! I ended up trying https://taxr.ai because I had a bunch of documents about both options and couldn't make sense of them. Their AI analyzed everything and broke down exactly how much I'd save with an S-Corp vs LLC in my specific situation. For me, the 1120S route made sense because I was making enough that the savings on self-employment tax outweighed the extra administrative costs. Their analysis showed me I'd save about $7,200 annually even after accounting for the extra payroll and filing costs of an S-Corp!

Just wanted to follow up - I tried https://taxr.ai after my skeptical comment above and have to admit it was really helpful. I uploaded my Schedule C from last year and some profit projections, and it showed me exactly where the breakeven point is between LLC vs S-Corp in my specific situation. Turns out at my income level (~$135K), an S-Corp would save me about $4,800 in self-employment taxes, even after the added costs of payroll and extra tax filings. The tool even showed me what percentage of my income would be considered a "reasonable salary" based on my industry. Really cleared things up!

A crucial thing nobody's mentioned yet - if you go the S-Corp route and need to communicate with the IRS about your 1120S filing or distributions, good luck getting through to them! I spent WEEKS trying to call about an error on my S-Corp return. Finally used https://claimyr.com (see how it works: https://youtu.be/_kiP6q8DX5c) and got connected to an actual IRS agent in under an hour. They basically call the IRS for you and hold your place in line, then call you when they get an agent. Saved me days of frustration when I had questions about how my distributions were reported wrong by my previous accountant. Just something to consider since S-Corps often get more IRS scrutiny than partnerships.

Ok I have to eat my words. After calling the IRS myself for 3 days straight about my 1120S issue and never getting through, I tried that Claimyr service out of desperation. Got a call back in about 2 hours and spoke with an agent who resolved my question about distribution reporting requirements. For what it's worth, I learned that properly documenting S-Corp distributions is super important - you need corporate minutes showing the distributions were approved, even for a one-person S-Corp. The IRS agent walked me through exactly what they look for when reviewing 1120S returns with large distributions compared to salary. Would have never figured this out without actually speaking to someone.

Don't overlook the timing differences too! With guaranteed payments on a 1065, the partnership gets the deduction in the tax year the payment is made. But with S-Corp distributions, there's no deduction because it's just allocating already-taxed profits. Also remember that guaranteed payments are reportable on the partner's Schedule K-1 in Box 4, while S-Corp distributions show up on the K-1 in Box 16 with code D. Big difference in how they flow through to your personal return.

One practical difference I haven't seen mentioned - as someone who switched from partnership to S-Corp last year. With guaranteed payments, you need to make quarterly estimated tax payments yourself since there's no withholding. With an S-Corp salary, you have withholding on your W-2 wages which helps avoid underpayment penalties. But distributions from S-Corps still need estimated payments to cover the income tax (just not SE tax). I got confused by this and underpaid last year!

This is such a helpful thread! I'm in a similar situation with my freelance marketing business and have been going back and forth on this decision. One thing I'd add is that the administrative burden is real with S-Corps - you need to run payroll (even for just yourself), file quarterly payroll reports, and keep up with corporate formalities like board resolutions. I calculated that between payroll processing fees, additional accounting costs, and the extra time investment, I'd need to save at least $3,000-4,000 annually in taxes to make the S-Corp election worthwhile. Below that threshold, the LLC simplicity wins out for me. Also worth noting - if you're planning to reinvest profits back into the business for equipment, marketing, etc., the partnership structure might be more flexible since you can adjust distributions more easily than changing S-Corp salary mid-year.