Partnerships and Taxes
UPDATED: February 8, 2020
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Business partnerships are taxed differently than other business entities, such as corporations. Further, the profit distribution of a business partnership may be set up so that the partners get the best tax rates that they can. As a new business owner, you may find that the benefits of business partnership taxation outweigh the benefits of forming another type of business structure.
Tax Benefits of a Business Partnership
A general business partnership offers the benefit of “pass through taxation.” This means that the business entity does not get taxed for the profits, but the individual partner does. If you become a member of a business partnership, any profits from the partnership is taxed as if they were your own income. While forming your business partnership, you most likely will have drafted a partnership agreement explaining the division of profits. Sometimes the agreement will specify equal profit-sharing, and sometimes there will be a larger owner who makes more of the profits. In either case, the individual is limited to paying partnership taxes on the percentage of profits that he or she takes home at the end of the day.
Limited Partnerships, Limited Liability Partnerships, and Partnership Taxes
In most states, a limited partnership (LP) generally offers the same taxation benefits as a general business partnership. Further, while every partner must pay income taxes, the limited partners in an LP will not have to pay self-employment tax on their share of the profits, since they do not play an active role in the business. However, in some states, LP taxation depends on several criteria, including how long the LP has been in business, the management structure, and how the limited liability portion of the business is set up. If your LP does not meet these minimum standards, it will not receive the benefit of pass through taxation, and be taxed as an entity instead. It is important to check your own state laws to ensure that you know the tax structure before you commit.
Limited liability partnerships (LLP) are generally taxed in the exact same way as general business partnerships. Even though the partners of a LLP have protected liability just as the limited partners of an LP do, they must still pay income tax, as well as a self-employment tax. This is because the partners of a LLP are not required to be passive to receive limited liability, as the partners of an LP are. Only certain states have enacted statutes that allow the formation of LLP’s, and often times, only licensed professionals can form such entity.
Getting Legal Help
If you have further questions about partnership taxes or business partnership laws in your state, you should talk to your accountant or a local business attorney.