What is a Partnership?

To understand limited liability partnership tax advantages, you must first understand a partnership and a limited liability partnership. A partnership can be formed with two or more people or entities. A partnership, which may also be referred to as a general partnership, occurs when those who are involved agree to own and operate a business together. Many different aspects of the business are then shared by the partners, including managerial duties, business profits, losses, and taxes.

What is a Limited Liability Partnership?

A limited liability partnership, unlike a general partnership, is structured in a way that protects the partners from some of the liabilities related to the business. For example, a limited liability partnership affords protection from the negligent behavior of another partner within the company, such as accumulating debt or the consequences of wrongful acts. In a general partnership, a partner may not have that protection from the other partner's actions, and may find himself responsible for the penalties of such acts.

Advantages of a Limited Liability Partnership

  • The partnership is not required to pay any taxes.
  • The percentage of interest each partner has in the partnership is used to determine how deductions, debts, and credits are divided.
  • Business ownership is flexible for the partners.
  • Partners have the ability to determine how they contribute to the business.
  • Managerial responsibilities can be allocated based on partner experience or may be distributed equally among all participants.
  • A partner may give up his right to make business decisions and simply have financial interest in the company.

Disadvantages of a Limited Liability Partnership

  • Some partners may take advantage of the amount of flexibility in this type of partnership.
  • Partners who don't have the company's best interests in mind may make decisions that follow their own personal priorities.
  • Some states may recognize a company as a non-partnership for tax reasons.
  • Some states do no recognize limited liability partnerships as true legal structures.
  • Some states limit the use of limited liability partnerships to specific industries, such as the legal or medical fields.
  • There is an extensive volume of paperwork required because of the separate legal status.
  • The partnership can be terminated easily if a partner decides to withdraw from the structure.

Taxes in a Limited Liability Partnership

There are two main ways that are used to file taxes for a limited liability partnership. The partners will have to decide whether the company will be taxed as an S corporation or as a C corporation. This is because the Internal Revenue Service (IRS) does not recognize a limited liability partnership as a tax classification.

For an S corporation, the business's taxes are typically paid on the partners' personal incomes since they draw salaries from the company. This is done in the same way taxes are paid by employees with standard jobs and is reported on the partners' personal 1040 forms. Taxes may also be filed as a C corporation, which is most commonly a large company that is publicly held. This type of corporation files tax returns for the business, rather than on the partners' personal returns.

For small limited liability partnerships, the partners may decide to pass the company's profits and losses through their personal tax returns. This is because it requires less paperwork and is much simpler than filing taxes as a corporation. There are a few forms that will have to be filed when claiming the profits and losses on personal returns, including a Schedule K-1 and Form 1065.

Important Aspects of a Limited Liability Partnership

The percentage of ownership for each partner is most commonly used to determine the split for profits and losses from the business. For example, if one of the partners owns 35 percent of the partnership, he would be responsible for 35 percent of the losses and 35 percent of the profits, unless it is decided differently. This percentage can be changed with the approval of the other partners and done through special allocation. However, the IRS pays close attention to special tax allocations, and professional tax advisors should be consulted before attempting to move forward.

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