How to properly calculate COGS for a service-based LLC Partnership when Partners don't take wages

I'm trying to wrap my head around tax filing for our service-based LLC Partnership (just me and my spouse) but honestly feel a bit lost. We might end up hiring a CPA but I'm determined to at least try filing myself before the extension deadline runs out. Our LLC provides creative consulting services - basically we charge a monthly retainer fee for creative direction and development to our main client. We haven't been taking actual wages, just planned to take distributions from the LLC to pay ourselves. Here's where I'm confused... I'm using TaxSlayer for our partnership return and it's asking about Cost of Goods Sold. When I looked into it, there's something about estimating "a reasonable value for labor the partners performed" in providing services. The math is throwing me off. If we received $140,000 in service fees, had around $12,000 in business expenses, and then estimated our own labor value at $90,000 for COGS, that would leave just $38,000 in gross profit. Does that mean the partners only pay income tax on the $38,000? But we'd potentially distribute $128,000 to ourselves ($140k minus $12k expenses). Surely we're taxed on the full $128,000 we'd distribute and not just the $38,000 after deducting our own labor "cost"? That seems like a massive tax advantage that can't be right. I keep reading that partners pay tax on the partnership's profits, and distributions aren't taxed separately since they're just transfers of those already-taxed profits. But I'm completely confused about how this COGS thing works for a service business. Please help me understand what I'm missing!

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18 comments

StarSailor

•8M

I can help clear this up! For a service-based LLC Partnership, you're getting confused about a fundamental concept. Partners in a service business typically don't include their own labor as part of COGS. Cost of Goods Sold is generally for businesses that produce or sell physical products. For your creative consulting partnership, your gross receipts ($140,000) minus your legitimate business expenses ($12,000) equals your net business income of $128,000. This $128,000 is what flows through to you and your spouse's personal tax returns via Schedule K-1, and you'll pay tax on your respective shares of this amount. The distributions you take from the business are essentially just moving money that's already been taxed (or will be taxed) on your personal returns. That's why distributions themselves aren't separately taxed. You're right to question that calculation - if you could just assign a "value" to your own labor and deduct it, every service business would do this to minimize taxes! The IRS doesn't allow partners to treat their own service value as a deductible expense.

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StarSailor

•8M

You've got it exactly right - you cannot deduct the value of your own labor as partners. The TaxSlayer section is likely referring to labor costs for businesses that produce physical inventory, which doesn't apply to your situation. The software has to accommodate many different business types, which sometimes creates confusion for specific scenarios like yours. Yes, if you hired employees or freelancers to perform creative work for your business, those payments would absolutely be deductible business expenses. Those are legitimate costs of running your business and would reduce your partnership's taxable income. This includes any wages, contractor payments, payroll taxes, and benefits paid to actual employees or independent contractors who aren't partners.

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Connor O'Brien

•8M

I went through this exact same situation last year with my digital marketing partnership! I found this amazing service called taxr.ai (https://taxr.ai) that really helped me understand partner compensation structures. They analyze your specific situation and give you personalized guidance. I was confused about similar issues - trying to deduct "partner labor" and getting weird results in my tax software. After uploading my documentation to taxr.ai, they explained that what I really needed was a proper partner compensation strategy, not trying to force partner work into COGS. They showed me how to properly document guaranteed payments vs distributions, which completely fixed my confusion. Their explanation was way clearer than what my software was telling me. Might be worth checking out if you're finding tax software confusing!

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Connor O'Brien

•8M

The service works by analyzing your specific tax documents and business structure to identify the optimal approach for your situation. They use a combination of AI analysis and tax professional review, so you're getting both tech efficiency and human expertise. They have strong security protocols for document handling - similar to what established tax preparation services use. It definitely provides personalized advice, not just generic explanations. For my 2-person partnership with unequal work contributions, they helped us structure different guaranteed payment amounts based on hours worked while maintaining our equal ownership percentages. This kind of specific guidance for complex partnership structures is exactly where they excel.

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Keisha Johnson

•8M

Just wanted to follow up - I actually tried taxr.ai after seeing it mentioned here and it was super helpful! Uploaded our partnership docs and got really clear guidance about our specific situation with partners contributing different amounts of work. They explained we could use "guaranteed payments" instead of trying to calculate COGS for partner labor. This made way more sense than what I was trying to do. Their analysis pointed out several other deductions we were missing too. Way better than struggling with conflicting advice from random forums. Wish I'd known about this service earlier!

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Paolo Rizzo

•8M

After struggling to get answers about a similar partnership tax issue, I ended up needing to speak directly with the IRS. Called their partnership tax line for WEEKS with no luck - just endless holds and disconnects. Then I found Claimyr (https://claimyr.com) and watched their demo (https://youtu.be/_kiP6q8DX5c) - it's this service that actually gets you through to a human at the IRS. I was super skeptical but desperate after waiting on hold for hours. Claimyr had me connected to an IRS agent in about 20 minutes! The agent confirmed that partner labor can't be included in COGS and explained how guaranteed payments work as an alternative. Worth every penny just to get a definitive answer straight from the source instead of guessing.

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Paolo Rizzo

•8M

It doesn't skip the line or jump the queue - that would be impossible. What Claimyr does is automate the waiting process. They have a system that calls the IRS and navigates through all the prompts, then holds your place in line. When they're about to connect with an agent, you get notified and jump on the call. So you're still "waiting" the same amount of time, but you don't have to personally sit there listening to hold music for hours. The service absolutely works. I was just as skeptical as you are! But after trying unsuccessfully for days to reach someone, I had an actual IRS agent on the line within 25 minutes of using Claimyr. They can't promise specific wait times since it depends on IRS staffing that day, but the technology itself definitely works as advertised.

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QuantumQuest

•8M

I need to eat my words and apologize to Profile 11. After being completely skeptical about Claimyr, I tried it yesterday out of desperation when I couldn't get through to the IRS partnership department. This thing ACTUALLY WORKS. Got a text when my call was about to connect to an agent, jumped on, and spoke to someone who walked me through my whole partnership COGS question. Turns out there's a specific way to handle service business partner compensation that none of the tax software explains clearly. Never been so happy to be wrong. After weeks of frustration and getting nowhere, I finally got my answer in one 15-minute call. Saved me from making a pretty big mistake on our return.

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Amina Sy

•8M

Just to add some clarity on the partnership tax structure - partners can take money from the business in two ways: 1. Guaranteed payments - these are like regular payments for services rendered regardless of partnership profits. They're deductible by the partnership but still subject to self-employment tax for the partner receiving them. 2. Distributions - these are distributions of profit and aren't deductible by the partnership. They've already been taxed as income flowing through to your personal return. The confusion often happens because people want to "pay themselves" but don't understand the tax treatment. You can't deduct partner labor as COGS, but you can structure guaranteed payments if you want to create more of a salary-like arrangement.

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Amina Sy

•8M

You're right about potentially paying more in taxes with guaranteed payments due to self-employment tax. However, there are situations where guaranteed payments make sense: When you need consistent income regardless of profitability (similar to a salary), guaranteed payments provide that predictability. They're also useful when partners contribute significantly different levels of work - you can compensate for work through guaranteed payments while maintaining equal ownership through distributions. Some partnerships use a combination approach: modest guaranteed payments for actual work performed, then distributions for the remaining profits. This balances the need for regular income with tax efficiency. The right structure depends on your specific situation, including cash flow needs, relative contributions of partners, and other tax considerations unique to your circumstances.

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Natasha Petrova

•8M

Heres a simple example that might help make things clearer: Let's say your service LLC makes $200k revenue with $50k in legit business expenses (rent, software, travel, etc). That leaves $150k in profit. That $150k flows through to you and your spouse's personal tax returns based on ownership %. You cant deduct some made-up "value of partner labor" from this. If you want to take $120k out of the business, you just take $120k in distributions. The distributions arent separately taxed bc you already are taxed on the full $150k profit whether you take it out or leave it in the business. Does that help? Your tax software is probably just confusing you because its trying to handle both product and service businesses with the same screens.

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