Imagine that you receive a request from your boss for a meeting this afternoon. You are not sure what the meeting will be about, but you prepare as much as you can. During the meeting, you are invited to become a firm partner—a very exciting step in your career. You will learn quickly that making partner can change your life in many ways, including impacting your finances. The rewards can be money, power and prestige, but with the title also comes responsibility and potential liability.
Partners are generally owners. As an owner, you will enjoy your share of the company’s profits, but, what if the company goes through hard times? There may be a “cash call,” meaning the company will need to either raise the money from partners or borrow from another source.
Consider the COVID-19 pandemic: many companies lost business for extended periods of time. Expenses and payroll continued, but income may have diminished, leaving the partners responsible for maintaining those payments.
How can you prepare to become partner?
Partnership Line of Credit
Establish a company line-of-credit. This is a revolving loan facility that allows tremendous flexibility due to its repayment and re-borrowing allowances. The interest rate may “float” with the market, but this type of loan lets your firm borrow whenever necessary. It’s imperative to set this up before an emergency.
Taxes and Phantom Income
If your partnership retains earnings, the company will hold some cash reserves for the needs of the business. In this case, partners will need to pay taxes on those retained earnings as if they received them as income. It’s called “phantom income” because you’ll pay taxes on it but won’t be able to spend it. You will need to plan to cover your portion of the tax liability.
The partnership itself is not a taxable entity, meaning that income or losses created by the business are passed through to the partners. Each will receive their distributive share, which is proportional to their ownership percentage.
Quarterly Tax Payments
Since you’re no longer an employee, your compensation isn’t tied to employer withholding of Medicare, Social Security and income taxes. A CFP® professional and tax specialist can help you determine your quarterly estimated tax payments.
Partnership Expenses for Personal Benefits
Partners are not allowed to participate in flex-spending plans offered to employees. These plans offer pre-tax payroll deductions for healthcare, childcare and even commute transportation costs, but as a partner, you can no longer receive tax benefits for these costs.
Saving for Retirement
Retirement savings plans offered to employees can still be used by partners. However, work with your tax specialist and CFP® professional to make sure that you meet some strict thresholds before contributing.
If you hold a critical role in the company, succession planning is critical.
Can the partnership survive if a critical partner exits? It is important to be part of the partnership buy/sell agreement. In the event of a sudden exit, this document specifies that the available shares be sold to the remaining partners on whatever terms the company has decided.
Your CFP® professional can help you understand the importance of considering a Disability Insurance (DI) policy. Disability Insurance will replace income if you become unable to work, and it’s portable if you ever sell your ownership and move to another venture. As a business partner, you will need to purchase this on your own.
Becoming a partner is an exciting accomplishment that comes with a number of advantages, as well as new responsibilities. Partners are owners and are no longer eligible to receive many of the benefits and services that employees receive. With planning and the support and guidance of a CFP® professional, you can ensure that you will be ready for the role.