Tax Issues Associated With Partnerships

A partnership formation is not a separate taxable entity from its owners; the Internal Revenue Service labels a Partnership as a “pass-through entity.” This categorization implies that the partnership itself is not susceptible to the income tax obligation for any profit earned. 

The business income of the partnership “passes through” the business to the individual partners, who in turn, are required to report their share of profits or losses on their individual income tax returns.

 Moreover, each partner is required to make a quarterly estimated tax payment to the Internal Revenue Service per year. Partners aligned with the formation are not employees. 

Because of this classification, they are not to be issued a W-2 form. Although the partnership, as a formation, does not pay taxes, it is required to file IRS Form 1065 (an information tax form) each year. This information form arranges each partner’s share of the formation’s profits or losses. 

The Internal Revenue Service reviews this information to ensure that the partners are reporting their income accurately. In addition to Form 1065, the partnership must also file Schedule K-1 to the Internal Revenue Service and to each partner. 

In turn, each individual partner is required to report the profit and loss information on their individual tax return (Form 1040) with the Schedule E attached. 

Because a partnership does not have a department to compute and withhold income taxes, each individual partner must set aside enough cash to pay taxes on their share of the formation’s annual profits. 

A partner must estimate their tax obligation they will owe for the year and provide payment to the IRS each quarter. 

The Internal Revenue Service will require each partner to pay incomes taxes on their distributive share. 

The distributive share refers to the individual’s portion of profits to which the individual partner is entitled to under the partnership agreement or state law (only if the partnership does not form an agreement). 

The IRS will treat each partner as though they received their distributive share each year. This ruling means that the partner must pay taxes on their share of the formation’s profits (sales minus expenses) regardless of how much money they actually earn or take from the entity. 

Individuals in a partnership—in addition to personal income taxes—are required to pay a “self-employment tax” for all of the profits allocated to the individual from the partnership. The self-employment tax will consist of contributions to Medicare and Social Security programs. 

Partners maintain different tax obligations than regular employees of a corporation or other business formation. Because an employer does not withhold taxes from partners paychecks, the partner must pay them with their regular income taxes. 

Furthermore, a partner must pay twice as much as employees, because the employees’ contributions are matched by their employer. 

 That being said, a partner can deduct of their self-employment contribution from their income, which in turn, lower their tax obligation. Enjoy your day.

3 Types Of Partnerships Explained

1. General Partnership: A general partnership is a form of business structure where multiple persons come together and agree on forming an unincorporated business model. A general partnership maintains the following features:

•       A general partnership is formed by two or more individuals

•       A general partnership is created by an agreement and proof of existence

•       The owners of a general partnership are all personally liable for all debts and legal actions that the company may face. 

•       A general partnership features partners who share equal liability and responsibility 

 2. Limited Liability Partnerships: A limited liability partnership is a type of partnership where some or all of the partners possess limited liability. The formation, thus, exhibits elements of corporations and partnerships. Under this formation, one partner is not liable or responsible for another partner’s negligence or gross misconduct. In a limited liability partnership, some partners face a level of liability that is similar to that of a shareholder in a corporation. That being said, unlike a corporate shareholder, a partner has the right to manage the business directly—shareholders elect a board of directors to handle the entity’s day-to-day business. The laws surrounding limited liability partnerships will vary based on a jurisdiction’s distinct laws. For example, some countries require a limited liability partnership to have at least one “general partner” with unlimited liability. A limited liability partnership is distinct from limited partnerships (in some areas) because a limited partnership will require the presence of at least one unlimited partner, as well as, passive and limited liability investors. Because of these regulations, in some countries, a limited liability partnership is better suited for entities where investors which to assume active roles in management.

3. Limited Partnership: A limited partnership is a business formation that is similar to a general partnership, except that in addition general partners, there are one or more limited partners. The limited partnership is therefore a formation where only one partner is required to face all liability (general partner). As is common in a general partnership, the general partners in a limited partnership maintain the authority to act as an agent—this allows them to bind all the other partners in contracts and other ventures. 

Like a shareholder in a corporation, limited partners have limited liability—they are liable on debts incurred by the firm to the extent of their initial investment and possess no management authority. The general partner will pay the limited partners a return on their investment (like a dividend). The extent and nature regarding the distribution of payment is outlined in the partnership agreement. As a result, a general partner will carry more liability, and if the partnership loses money, the general partner is held liable.  

A partnership is an arrangement by which two or more legal persons join together in order to work together for a particular purpose. The primary form of a partnership is a business partnership, which is a partnership between individuals who have agreed to work together for the sake of advancing a business purpose. Partnerships do not have to be business partnerships, as it is possible for organizations to form partnerships with other organizations without any kind of business interest. For example, marriage itself, under certain circumstances, might be understood as a form of partnership between two individuals. The mention of legal entities in terms of partnerships was made specifically because it is possible for corporations to make  partnerships with one another. For example, two large corporations could form a mutually beneficial business partnership with full legality, as corporations are technically legal entities.

The different purposes to which partnerships can be put define the nature of those partnerships. For example, a partnership between two different schools that allows those schools to help students exchange between the two schools, and thus, take a greater variety of classes is entirely different from a business partnership in which two corporations work together in order to earn greater profit. Nonetheless, a business partnership is one of, if not the single, most common forms of partnerships in the world today. This is in part due to the effects of a business partnership upon taxes for the constituent parties of that partnership.