Partnership Tax Return: Everything You Need to Know
Filing a partnership tax return isn’t hard as filing taxes for a corporation.7 min read
Partnership Tax Return
Filing a partnership tax return isn’t hard as filing taxes for a corporation. For partnerships, paying taxes does mean learning a few somewhat unfamiliar terms, such as “distributive share," and "special allocation," but once you are familiar with them, the tax return function becomes fairly easy to understand.
Since partnerships do not have corporate tax status, the Internal Revenue Services does not have any power to tax them directly. Although partnerships aren’t taxed, they are still required to file a tax return every year, unless the partnership doesn’t have any income or expenses.
The Internal Revenue Service taxes the partners in the partnership on the profits that trickle down to them as personal income. With a personal income tax return, you'll need to learn about the issues involved with reporting gains and losses from a partnership.
Whether operating as a general partnership or a limited partnership filing business taxes follows the same procedure, though limited partners are subject to slightly different rules of taxation than general partners.
Filing Tax Forms
Though a partnership doesn’t not pay income taxes, it still must file Form 1065 with the Internal Revenue Service. Form 1065 is informational in nature, one that the Internal Revenue Service reviews to make sure that the partners are correctly reporting their income.
A Schedule K-1 also must be provided to the Internal Revenue Service, and to each partner, by the partnership. A Schedule K-1 breaks down the business's gains and losses according to each partner’s share of the company.
Specifically, the K-1 form lists:
- The partner’s name, address and percentage share of profits, losses, capital and liabilities.
- The partner’s share of ordinary business profits or losses, rental profits or losses and interest income.
- The partner’s self-employment income, credits and distributions.
Each partner also must declare this information on their individual tax return, with a Schedule E form attached.
Most partnerships can file tax forms electronically or through the mail.
When are Partnership Income Tax Returns Due?
Form 1065, along with the partners’ individual Schedule K-1 forms, is due March 15 of the year following any given tax year. If March 15 happens to fall on a weekend or holiday, the next business day becomes the due date. An application for an extension is for six months, so then taxes should be filed by September 15.
Who Pays the Taxes - the Partnership or the Partners?
The partnership income taxes are paid by individual partners, based on their share of gains and losses. Any income from the partnership is distributed among them every year.
Are LLC's Taxed Differently from Partnerships?
In terms of taxes, partnerships and LLC are the same. The Internal Revenue Service does not recognize an LLC as a taxing entity, so multiple-member LLC's file partnership taxes, as described above.
How Partnership Income Is Taxed
The Internal Revenue Service considers partnerships to be "pass-through" tax entities. This means they are not viewed as being separate from their owners for tax reasons. With partnerships, business profits are not subject to income tax, but instead “pass through” to the business owners, who must then report the income or losses from their businesses on their personal tax returns.
Estimating and Paying Taxes
With a partnership, there is no employee who figures and withholds income tax for the partners. Therefore, they must each estimate this figure for themselves and take steps to ensure they have reserved enough to pay their share of taxes on the partnership’s annual profits. Partners must pay the Internal Revenue Service, along with the proper state tax agency, their estimated taxes for the year on a quarterly basis - in April, July, October, and January.
Profits Are Taxed Whether Partners Receive Them or Not
The Internal Revenue Service requires that partners each their income taxes according to their "distributive share." Distributive share is a term meaning the amount of company profits to which each partner is entitled, depending either on a partnership agreement or state law.
The Internal Revenue Service acts on the premise that each partner has, in fact, received their distributive share each year. Therefore, partners must pay taxes based on that amount, no matter how much they actually withdrew from the business in any given year.
Establishing the Partners' Distributive Shares
State laws typically assign profits and losses to partners based on their ownership interests, or distributive shares, in the business. A “special allocation” is a method of dividing profits and losses in a way that is not proportionate to each partner’s specific interest in the company. This requires that careful attention be paid to the Internal Revenue Service rules regarding this process, and that those rules are followed carefully.
If you are actively operating your partnership, the Internal Revenue Service expects that all taxes on self-employment income be paid by you, as well as income taxes. These are taxes from your salary that are based on deductions for the Social Security Administration, as well as for Medicare. These are just like the taxes that are taken out of every employee’s check. However, some differences exist between the deductions from a regular employee’s check and those of partners’.
Because they are not withheld from the income that partners receive, partners must pay these taxes along with standard income taxes. Also, partners must pay double the amount that regular employees do, because employers match their employees’ contributions.
After a partner deducts all expenses from his business income, it will greatly reduce the profits that must be reported to the Internal Revenue Service. Expenses that are deductible include any business-related expense, such as start-up costs, costs for traveling on business, operating expenses, in addition to outlays for advertising. Partners may also deduct a percentage of what they spend on business-related meals and entertainment as well.
When a partnership chooses to distribute its profits using a different method from what is outlined in its partnership agreement, this is known as a special allocation. The rules for special allocations are fairly complex. It is best to discuss making a special allocation with a tax lawyer before attempting the necessary procedures yourself.
Other Partnership Taxes
Partners must consider many tax issues before filing their tax returns. Partners are seen as being self-employed, rather than as employees in a partnership. Therefore, they must to file a Schedule SE along with traditional tax return forms in order to pay self-employment taxes. Self-employment taxes provide for a portion of Social Security and Medicare taxes.
Partners must pay twice of what a normal employee would pay in self-employment taxes - employers usually match employee tax contributions, but a partner’s taxes owed are reduced their ability to deduct half of their self-employment contribution.
Decreasing Your Tax Burden Through Deductions
Paying the above taxes can be complex, and a procedure that can shake someone in their boots when mentally estimating their financial burden tax-wise, partners are eligible to take a deduction for any business-related expenses they incur. This is often a significant amount of revenue and can greatly reduce a partner’s taxable income.
A corporation, as opposed to a partnership, pays taxes on all corporate income that is left in the company at the end of a fiscal year. The owners only pay taxes on what they receive in return for services performed for the company. For instance, a salary or bonus would qualify as income for which they are personally responsible to pay taxes on. Dividends also fall into that category.
Incorporating a company offers businesses a tax advantage over a partnership’s process of “pass through” taxation. Still many small business owners are wary of having to file corporate income tax. But if a business owner thinks that it will retain income year over year, incorporating can offer a lower tax rate on the first $50,000 to $70,000 in income each year.
Filing Business Taxes for a Partnership
Partnerships are required to file a federal partnership tax return for I.R.S. Form 1065. On Form 1065, you will need to deliver the partnership’s total profits and losses. Deductions that can be included on this form include rent, taxes, repairs to the business, definite payments to partners, depreciation, employee benefit programs, and of course, salaries.
Schedule B comprises a sequence of questions regarding your partnership. This includes anything from the kinds of partners and ownership of corporate shares to kinds of distributions made.
Schedule K is a timetable of expenses and income that creates the basis for the K-1 forms that are issued to shareholders.
Schedule L is a balance sheet. Certain partnerships are obligated to finish schedules M-1, M-2 and/or M-3.
The return must be signed by a general partner.
To File Business Taxes for a Partnership: File State Tax Returns
Certain states necessitate partnerships to file a state tax return. A partnership may have to pay franchise taxes, excise taxes, or sales taxes. Tax filing necessities for each state can be found online. Simply search for a particular state’s department of revenue website.
Filing Business Taxes for a Partnership: Filing Personal Tax Returns
Limited, or general, partners need to report their share of partnership gains or losses on their federal income tax return. The schedule K-1 form that the partnership distributes will have all the information necessary to file these numbers.
Filing partnership taxes has many steps. It would be wise to discuss it with an accountant or at the very least, to acquire some tax preparation software to make sure filing these taxes are done correctly. Avoid late filing penalties by complying tax filing deadlines at both the state and federal levels.
Get Expert Help
Plan to get the help you need from a tax adviser who specializes in partnership taxation, to make sure you comply with the complex tax rules that apply to your business and stay on the good side of the Internal Revenue Services.
Whether you're just starting your partnership and need a better understanding of your tax obligations, or have other legal needs, it's often in your best interests to contact an attorney before making important legal decisions.
Setting up a Corporation
A partnership may be favorable, but under some circumstances, setting up a corporate entity has tax advantages.
The most prominent difference with regard to taxes between a partnership and a corporation is that partners are responsible for paying the taxes of the partnership on their individual tax return, while corporation are taxed directly by the IRS and pay through corporation.
Even if partners in a partnership agree to leave money in the entity e.g. for expansion, rather than pocketing the entire profits, the partners still pay personal income tax on the money left in the partnership.
If you need help filing a partnership tax return, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top five percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and have an average of 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.