A limited partnership tax return must be filed annually in order to report the income, deductions, losses, gains, etc., from a limited partnership's operations. Limited partnerships do not pay income tax. Instead, they will "pass through" any profits or losses to partners. Each partner will include their share of a partnership's income or loss on their tax return.

A partnership is created when two or more persons join together in order to carry on business or trade. Each person contributes labor, skill, money, or property into the company in order to share in the profits of the business.

What Is a Partnership?

A partnership occurs when a business is owned by several individuals that have agreed to a partnership agreement and have made the appropriate investments into the business.

How Are Limited Liability Companies Taxed?

A limited liability company (LLC) that has more than one member will usually be taxed as a partnership because the Internal Revenue Service (IRS) will not acknowledge the LLC as a business entity regarding tax purposes. Single-member LLCs are taxed as sole proprietorships and not partnerships. An LLC with one business owner must report income on Schedule C of its personal tax return.

What Are the Tax Implications of a Limited Partnership?

A general partnership operates similar to a limited partnership (LP). An LP business will have two or more partners; one is considered a general partner and the other is a limited partner who is a passive investor and not considered an active investor in the business. General partners (GPs) are responsible for the daily operations of the organization, while LPs do not have authority to dictate how the business is run. LPs are taxed similarly to partnerships with the pass-through taxation process. However, the roles of limited and general partners do impact the amount of tax that partners will pay.

The pass-through taxation method for LPs carries the profits and losses from the business to the individual tax returns of the partners. In turn, the partners are taxed based on their partnership agreements and are usually allocated based on the percentages of business ownership. For example, when an owner controls 50 percent of the business, they will receive 50 percent of the profits or losses.

A key benefit of an LP business is that pass-through taxation restricts profits from being taxed twice. Therefore, profits will be passed down to the partners' level and the organization will not be taxed. On the other hand, corporations are taxed at the business level and again when the shareholders receive any dividends.

A significant advantage of a corporate tax structure is the ability to retain earnings. A significant number of corporations may retain up to $250,000 in net profits from being appropriated out to stockholders. These funds may be used for building renovations, purchasing equipment, etc. Remember, the goal of pass-through taxation is to not retain earnings.

When a business incurs more losses than profits, the partners of an LP may deduct losses up to the amount that they've invested in the business. They may even carry any excess loss to prior and future years to offset any profitability during those periods. LPs have the ability to carry losses forward 20 years and back two years.

Limited partners do not actively take part in the day-to-day operations of the business, and therefore are not required to pay self-employment taxes. On the other hand, GPs must pay self-employment taxes, which are Medicare and Social Security taxes combined, accounting for about 15 percent of a partner's net income.

How Are Partnerships Taxed?

Partnerships are not required to pay federal income tax. Rather, a partnership's net income/loss is passed through to the individual partners themselves, who must then report and pay taxes on their personal income tax returns. Unless the partnership does not have any income or expenses, it is required to file an annual tax return. The submitted return will acknowledge the partnership's:

  • Total income.
  • Total deductions.
  • Total credits.
  • Each partner's share of the business.

Remember, partnerships may be required to file and pay state taxes. GPs and LPs will follow similar procedures for filing taxes. However, LPs are subject to a marginally distinctive tax treatment when compared to GPs.

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