Partnership planning: Promotion to partner

What does the LLP agreement say?

A surprising number of LLPs still operate without an up-to-date LLP agreement but, whether or not there is one, you should be aware of the arrangements for capital contributions, profit sharing, the firm’s drawings policy and tax reserving policy.

How much capital will you need to pay in?

Partners in professional practices are usually required to make a capital contribution which is repayable upon leaving the firm.  The amount of capital will vary according to many different factors, e.g. the firm’s size and its cash flow requirements.  Generally speaking, we see capital contributions ranging from £50,000 to £400,000.  The most common way to finance them is to obtain a partner capital loan from a bank but, if the size of the loan does not meet the bank’s minimum lending threshold, it might instead be financed by restricting the partner’s drawings over a period of months.

How will your share of profit be determined?

Rather than receiving a salary which is taxed under PAYE, you will instead receive a share of the firm’s profit.  Often this share is only estimated at the start of the financial year and is not precisely determined until several months after the year-end once the firm’s financial profit is known.  Your share of profit might comprise several, internally defined elements including a fixed share, a performance-related share, a “bonus” share, and a further, variable share.  The total of all these elements comprises your remuneration and should be taxed via your self-assessment tax return.

How will your remuneration be paid to you?

There should be a drawings policy which allows partners to draw, monthly, a proportion of their remuneration, with additional lump sums drawn periodically as cash flow permits.  Newly self-employed partners should make sure they understand the relationship between the money they draw out of the business each month and the proportion of their share of profit this represents.  It is not uncommon for partners to become overdrawn – meaning they have drawn more than the total share of profit allocated to them – and this can lead to them owing money back to the LLP. 

How will you be taxed?

Some LLPs withhold a portion of each partner’s monthly earnings and retain it in the firm’s bank account until such time as the partner’s tax liability falls due in January and July each year.  Other LLPs pay its partners gross and leave it up to the individual to reserve a sensible percentage for tax and to ensure payment is made to HMRC when the liability falls due.  If the LLP maintains a tax reserve on your behalf, it is still up to you to make sure there is enough set aside for tax purposes.  Your tax liability doesn’t just cover your business earnings; it also covers non business-related earnings such as rental and investment income.  If these elements are significant, it could mean the tax reserve maintained by your firm is not sufficient to cover your tax liability, in which case you will need to provide the additional sum from a personal bank account.

What is the retirement age?

It might seem strange to be looking ahead to retirement just as you’re appointed a partner, but it important to recognise that the retirement age of a self-employed partner might be younger than that of a salaried partner or associate.  If you are planning to work until your state retirement age (age 66 and rising), this might not be possible under the terms of the LLP agreement where mandatory retirement clauses are still quite common.