Partnerships are a popular option in the business community with members enjoying added liability protection and increased capital raising potential. Simply choosing a partnership structure without doing your due diligence leads to trouble down the road. From problems dissolving the business to unfavorable tax situations, you want to be an informed business owner.
Partnership accounting experts want you to understand your obligations before formation, realize that distributions can become complex, follow all applicable tax deadlines, be aware of the additional deductions and credits available, and comprehend dissolution provisions.
Understand Your Obligations Before Formation
Whether you are forming a partnership from scratch or are joining an existing business, you want to have transparent insight into your obligations before you sign on the dotted line. There are different partner types, including a general member and a limited member. A general partner is liable for the company’s debt while a limited partner’s share of company debt is limited to their investment in the company.
For example, let’s say the partnership has $100,000 of debt that they default on. There are two general partners with 40% ownership each and a limited partner with 20% ownership. The limited partner has $15,000 invested in the company. Even though the limited partner’s share of company debt is $20,000, they would only be required to pay $15,000 with the general partners splitting the remaining balance.
Before you sign a partnership agreement, you must understand your liability obligation. Acting as a general partner not only constitutes a riskier investment but can also subject your income to self-employment taxes. The Journal of Accountancy suggests that you consult with an attorney when you are presented with a proposition.
Distributions Become Complex
Partnership agreements are as good as law when it comes to taking distributions from the company. The amount you are able to distribute needs to be proportionate to your ownership or profit percentage, which is specified in the partnership agreement. Distributions can cause issues between partners when certain partners don’t want to take money out of the company. This calls on the importance of communication and transparency between partners.
Let’s say you wanted to withdraw $5,000 from the company and you have 50% ownership. The other partners would need to withdraw the same amount, so if there were only one other person, they would also need to have $5,000 withdrawn. This doesn’t mean they must immediately withdraw the money when you do. Instead, there will be a distribution payable account on the balance sheet.
Follow Tax Deadlines Throughout the Year
Partnerships pass all income or loss down to the individual level through Schedule K-1. Unless you elect to pay entity-level taxes at the state level, you will be on the hook for federal and state tax obligations when you file your personal return. This gives way to the need for quarterly estimated tax payments either at the corporate or individual level.
In addition to estimated tax payments, your partnership must file an annual tax return on Form 1065. The 1065 has a due date of March 15th each year, but you can request an automatic 6-month extension. Moreover, you may have payroll tax and sales tax obligations throughout the year, depending on your business operations.
Additional Credit and Deductions are Available
Owning your own business leads to additional tax credits and deductions. Partnership business owners are able to take the Qualified Business Income Deduction, which is an immediate 20% reduction of taxable income. This means you will only pay tax on 80% of the profits your business makes. There is no additional deduction for losses passed down, but these amounts can be carried forward to offset future income years.
In addition to deductions at the individual level, partners are able to enjoy various deductions at the partnership level. COVID relief is still in full swing, with the Employee Retention Tax Credit being available for partnerships with employees. Moreover, the Research and Development Credit, Solar Powered Tax Credit, Fuel Credit, and more are options depending on the industry you operate in. Maximizing the credits that the IRS offers is crucial to reducing your tax liability.
Dissolution Requires Unanimous Vote
Whether your partnership has been struggling to turn a profit or partners simply aren’t getting along, dissolution is an option that many members resort to. Dissolution can be difficult because it requires a unanimous vote to legally dissolve the business in most states. Buying out partners is an option, but this can be expensive depending on the member’s basis in the company.
Be sure your partnership agreement has set clauses on how to dissolve the partnership. You may be able to bypass certain state guidelines if you have adequate clauses worked into your agreement. Regardless, you must understand the complications dissolution presents when it comes to your partnership.
Partnership accountants shouldn’t be the only individuals who understand the specifics of operating a partnership. In fact, as a business owner, the burden falls on you to know what accounting guidelines you must abide by. Partnerships carry an abundance of benefits that can be fully utilized the more informed you are regarding the rules and regulations that apply.