Taxes And Partnerships

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Partnership taxation involves taxing a business entity that is classified as a partnership. Partnership businesses require special tax regulations due to their complexity. A business partnership may be defined as an unincorporated organization with two or more members, if its members are engaged in a trade, business, financial operation, or venture and divide its profits.

A partnership may not be formed strictly to share expenses, however. Individuals are not required to complete any paperwork to create a partnership; the arrangement begins as soon as they begin doing business with one another. Many partners work out the details of the business management model in a written partnership agreement even though the law does not require it. If there is no partnership agreement put forth, the partnership laws of the appointed state will be the governing laws for the business.

Unlike corporations, partnerships are very informal business structures. Partners generally share equally in the management of the partnership and its profits and losses. Both parties also assume equal responsibility for the business's debts and liabilities.

Business partnerships are considered to be pass-through entities for the purposes of taxation. Therefore, the profits and losses of the partnership pass through the business to the partners. The IRS does not consider partnerships to be separate from their owners for the purposes of taxes. The partners pay taxes on their share of the profits on their own individual income tax returns.

Even though the partnership itself does not pay income taxes, it still must file IRS tax forms. The form it must file is an informational return that the IRS reviews to determine whether the partners are reporting their income correctly. The partnership must also provide a schedule that discloses each partner's share of the business's profits and losses. Each partner will then also report this profit and loss information on their own individual tax returns.

Each partner must pay income taxes on his or her distributive share. The distributive share is the portion of profits to which the partner is entitled under a partnership agreement. If the partners did not make such an agreement, then their portions will be determined by state law. Each partner must pay taxes on his or her share of the partnership's profits, regardless of how much money was taken from the partnership. Furthermore, even if partners must leave profits in the partnership to cover expenses or expand their business, each partner will still owe tax on his or her portion of the profit. It's possible for partners to divide their profits and losses in some way other than being proportionate to the partners interests in their business. Doing so is called a special allocation, which requires careful adherence to IRS rules.

Because partners do not have an employer to withhold income taxes for them, they each must be diligent to set aside enough money to pay their tax share on the partnership's annual profits. They need to estimate the amount of tax owed for the year and be prepared to make tax payments on a quarterly basis.

Another form of partnership is called a limited partnership. This type of partnership is greatly different from the general model. Limited partnerships usually have at least one general partner who control the companies day-to-day operations and is personally liable for debts. Limited partners contribute money to the business, but have little control over the happenings of the business itself. The benefit to the limited partner, for giving up management power, is that their personal liability is maxed at the amount that they've invested. If there is any debt from the partnership, the limited partner's investment can go toward the payment of the debt, but their personal assets cannot be touched.