My wife is a partner in a small business. The other partner in her LLC lives in a different city and does not contribute to the day to day operations of the business. Although the partnership is equal, it was agreed that my wife would take a certain amount as admin salary/fee.===> You mean guaranteed payments; Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. Owners of partnership (partners) and LLCs (members) do not get paid wages. Their 'pay' is in the form of capital distributions which are based on % ownership...most of the time.
During the first few months she could not take the admin salary as the business was not generating enough profit. Both partners agreed to consider the unpaid admin fee as arrears. =====> Guaranteed payments to partners are payments that are guaranteed to be made to a partner irrespective of whether the partnership makes a profit or not. Guaranteed payments to partners are made to ensure that partners are compensated for specific contributions they make to a partnership, whether in the form of goods or services. This eliminates the risk of their making personal contributions of time or property for which they are never paid if the partnership is not successful.
For tax purposes, can my wife report the arrears as investment?======>I guess so either investment or capital contribution in the PS. The IRS, courts, and practitioners generally take one of two approaches for the treatment of guaranteed payments: treating such payments as a separate item in the nature of interest or rather as a distributive share of partnership income. The characterization of those payments as interest like or as a distributive share can lead to vastly different tax consequences for the recipient. The law is notoriously conflicting, and it seems the best taxpayers can do is to make a judgment call based on their particular circumstances, taking into account the history and languageofthestatuteandthewayithasbeenapplied in different contexts by the courts, Treasury, and the IRS.
During the next year assuming that the business generates enough profit - these arrears could be reported as income==>Yes and it is as you can see subject to self employment taxUNLESS the partner?s , your spouse, portion of the PS?s loss exceeds the income.