Partnership tax liabilities refer to what taxation the owners of a partnership are responsible for. As a pass-through entity, partnerships are not taxed as a business, but their owners are taxed on their income from the business.

What Is a Partnership?

When an entrepreneur decides to start a business, they have four distinct business entity types to choose from:

  • Corporation
  • Limited liability company (LLC)
  • Partnership
  • Sole Proprietorship

The type of entity that a business owner chooses to form has a direct effect on how their business will be taxed. Certain entities are viewed by the IRS (Internal Revenue Service) as their own taxable entity, and others are called "disregarded entities." The business owner will elect a specific classification when they start their company.

Unless a limited liability partnership is formed, the owners of a partnership are held personally liable for any debts or legal issues that come up with the business.

Partnership Taxation

Small business owners can have a lot to handle when it comes to their taxes. From complicated bookkeeping to employee withholdings, handling the finances of a small business is no easy feat. The owners of a partnership also must understand distributive shares, substantial economic effects, and special allocations. If such matters seem overwhelming, it can be beneficial to hire a business lawyer.

Partnerships are formed when two or more individuals decide to start a business and give capital contributions in the form of money or property to get things up and running. These individuals are called the company's partners. As the owners of a pass-through or flow-through entity like a partnership, the partners absorb all of the profits and losses of the business.

Because the company's income passes on to the partners, the business itself is not taxed, but the owners are, thus avoiding double taxation. Even though the business doesn't pay taxes, it still must file an informational tax return.

Who Can Form a Partnership?

Most small business owners have the option to form a partnership, provided they find at least one other partner to join them. There are a few restrictions on the types of businesses that can choose the partnership structure, however. Some of these business types include:

  • Tax-exempt organizations
  • Insurance companies
  • Real estate investment trusts

Frequently, spouses will choose to form a partnership when they own a part of community property as a qualified entity. A partnership makes sense because the business is owned by two individuals, but they may choose to form a sole proprietorship instead.

Partnership Law

The rules and regulations regarding partnerships vary by state, but the Revised Uniform Partnership Act (RUPA) brought some uniformity to the laws. When forming a partnership, one should always double-check the requirements in their state to be sure they are compliant.

Advantages of a Partnership

Partnerships offer tax advantages that some other entity types do not. Some pros to consider are:

  • Freedom in profit distribution amounts
  • Easy filing requirements
  • No double taxation
  • Simple process for dissolution
  • Tax-free liquidation

General Partnership vs. Limited Partnership

General partnerships allow all partners to be held liable for business debts, but limited partnerships only hold one partner liable. The partner responsible for business debts in a limited partnership is called the general partner. A limited partnership can have one or more general partners. Other partners not held liable for business debts are called the limited partners. Limited partners can only be held liable up to the amount that they originally gave to the company, called their capital contribution.

To form a limited partnership, the owners have to register their business with the SOS (Secretary of State) or other appropriate state department depending on where they form. Shares may only be publicly offered if the company is registered with the SEC (Securities and Exchange Commission). Usually, if a limited partnership offers shares to the public, these investors would be treated as limited partners.

Who Can Be a Partner?

Any of the following individuals and entities can be partners in a partnership:

  • Individuals
  • Estates
  • Trusts
  • Associations
  • Corporations
  • Other partnerships

Partners are required to contribute to the business in some form whether that be with money, services, or property. This contribution is the partner's initial capital or capital interest, so their ownership percentage will be based on the amount of their contribution.

If you need help with partnership tax liabilities, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.