Partner Compensation Models (2024)

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• September 2005 Member
• Partner Compensation Models

Source: The CPA Journal

Because capital may have an impact on partner compensation, this article begins with a discussion of the variations among firms in partner capital contributions. Some firms require an immediate capital contribution and credit the partners’ accounts with interest on their balances. Often the capital contribution is paid in over a period of years, which can be a problem, as it was in the case of Arthur Andersen, if the firm fails and some partners owe payments but no longer have the income source from which to make them. A variation of this is to have partners pay a percentage of their compensation to the firm to be added to their capital accounts. If the firm fails they no longer have any obligation.

Here are some compensation and retirement payment methods:

• Corporate model—There is a salary plus a performance bonus. Firm earnings in excess of this are allocated on the basis of capital accounts. This system has the advantage of rewarding productive partners even though the firm as a whole may suffer in a particular year.
• Partnership apprentice model—New partners cannot participate in profits for a period of three or four years after admission to the partnership. Partners can purchase additional units based on partnership and individual partner performance. This method allows the firm to observe the new partners’ performance for a time before sharing profits with them, but can be perceived as unfair by the new partners.
• Traditional model—There is no guaranteed compensation. Partners receive a distribution based on anticipated earnings, which are allocated on the basis of capital accounts. Partners can buy additional capital units based on their performance. The drawback is that it creates friction when older partners’ production and performance declines, but their capital accounts do not.
• Funded retirement plans—Under one method, partners contribute after-tax dollars to a retirement fund. Investment income is added to it. Tax has already been paid. so the retirement payments are tax-free. One advantage of this method is that younger partners don’t have to fund the retirement of older partners. But the tax on retirement benefits is higher than it would be if it were deferred. A second method is a defined benefit plan, which forces the partners to set aside retirement funds, and is better for tax purposes.
• Unfunded retirement plans—Since payments come out of current income, the compensation of remaining partners can be affected, especially in a down year. One firm had an unfunded program based on the partners’ income 10 years prior to retirement. But this method permits older partners to coast in their final years.

From The CPA Journal, August 2005. For the complete article, click on the following link:
http://www.nysscpa.org/cpajournal/2005/805/essentials/p62.htm.