Authored by K. Thor Jensen in Taxes
Published on 07-04-2009
In these post-crash days, many people who have been cast adrift from their day jobs are working rapidly to establish new ways of making their income. However, it’s not wise to simply jump head-first into establishing a new business without assessing the tax responsibilities that will present themselves. One of the best ways to mitigate those burdens is to establish your new business as a partnership. In this article, we will examine how the U.S. tax code treats business partnerships and how you can make the most of it.
There are a number of ways to establish a business, each with their own pluses and minuses. For a small business, the most common initial choice is a sole proprietorship, in which gains and losses by the business are considered personal income by the owner. Another common choice is a corporation, which creates a new legal entity that is held by a single or multiple individuals. However, if you are starting a business that you expect to pay an immediate salary, a business partnership may be an intelligent compromise between those two options.
The most immediate benefit of establishing your new enterprise as a business partnership is the elimination of double taxation – at the end of the fiscal year, the company passes net profits on to the partners without removing Federal or state income tax. The individuals then pay taxes on the percentage of the profit they take home. This reduces a major expense in the running of the business and lets the owners take advantage of a large number of small business deductions in their personal tax returns.
In addition, partners in this sort of business organization have the legal capacity to make “special allocations,” assigning property, income or debt to other partners in amounts that don’t match their actual ownership. This can be exceptionally useful for deductable line items such as depreciation, which can be shifted over to the partner who needs it most on his return. This isn’t something that I would recommend be done without the advice of a gifted accountant, but it can be a useful weapon to have in your arsenal come tax time.
In addition, business partnerships have an additional advantage over corporations in the rules that govern transfer of property into or out of the business. Most C corporations are taxed on property disbursements, automatically shaving value off of any purchase or sale, but partnerships typically do not pay the same tax. This can be incredibly useful if the business is used as a holding mechanism for real estate or other high-value property. Also, if the partnership comes to a close, the remaining members will only be taxed on liquidation income once, as opposed to the double taxation that again plagues corporations.
A business partnership does carry with it additional liability, but the financial gains to be made make it a very attractive proposition for a new entrepreneur. As always, consult with a trained financial professional before trying to pull anything over on the IRS. Best of luck!