Filing taxes for partnerships is different from single-member LLC taxation. The IRS has some special regulations, so if you're running a partnership firm, you have to be aware of these rules, and file accordingly.
In the eyes of the IRS, the partnership business is considered to be a pass-through entity. What this means is, that the profits and the losses incurred by the partnership firm get passed down to the owners or partners. So they have to individually pay taxes on their profits or losses.
In most cases, partners of a business have an agreement that determines their percentage of share in the business. The calculation of profits or losses will follow this agreement.
The partnership itself as a business entity doesn't have to pay taxes, because the partners are paying the taxes. But still, the business has to file Form 1065, which evaluates whether all partners are reporting and paying their taxes correctly.
The business also needs to provide Schedule K-1 to all the partners, which details the share each partner holds in the company's profits and losses. The business needs to provide Schedule K-1 to the IRS as well.
And while filing individual taxes, each partner has to furnish this information on their tax return and compute taxes accordingly.
As the partners are liable to pay taxes for the partnership business, you and your partners have to be prepared to bear the expenses. There is no withheld tax for your business model, so you have to do the calculations by yourself, and have funds ready. The best way to go about this is to keep aside a portion of your income every month, so that when it's time to pay quarterly taxes in April, July, October, and January, you have enough funds in hand. Paying taxes on time is important to avoid extra interest and penalty charges.
Distributive share is an important concept for all partnership firms. The allocation of profits (or losses) from the business that each partner receives, is known as the distributive share. Since the partnership firm is not paying taxes, the partners pay taxes on the distributive share they receive.
The amount of distributive share can either be determined by a pre-established contract or based on the ownership. For example, if person A and B run a partnership business and both have equal ownership over the firm, they will receive an equal share (50% each) of the profits and losses, or as agreed upon in their contract, if they have one.
Besides paying income tax, you are also entitled to pay self-employment taxes as a partner. You have to submit schedule SE (Form 1040) for this purpose. Self-employment tax includes social security and Medicare contributions, similar to what employees at a firm pay.
However, this tax is not exactly identical to the taxes paid by employees. You are one of the owners of the business, so there is no employer above you who deducts these taxes from your paycheck. Employees' contributions are matched by their employer, but there is no employer to do that in your case, so you'll have to pay double.
Sounds too much? The good news is, you can claim half of your self-employment tax contribution as a deduction.
The Tax Cuts and Jobs Act (TCJA) of 2018 opened up a new tax deduction for pass-through business entities. As a partner, you can deduct 20% of your net business income from your total tax liability. This law is applicable till 2025 unless further extended by the government.
You and your partners are also eligible to deduct actual business expenses, such as the cost of running a firm, advertisements, marketing, operation costs, meals, travel, and so on.
Filing taxes for a partnership business can be a little tricky, more so if you're doing it for the first time. You have to look for the best way to file your taxes so you can legally minimize your tax liability as a partner. And for these strategies, you'll need to seek guidance from tax professionals. With their assistance, planning, computing, and filing taxes become super seamless.
If you are part of a partnership business and you're not sure how to go about with taxes, Accountants Now is here to help you out. Our tax experts will take care of every little thing on your behalf, starting from bookkeeping, payroll, to filing taxes, so you can run your business without any headache. Get in touch with us for more details.
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