A partnership is a pass-through entity that pays no business federal taxes, has partner liability protection, and can reduce personal, federal income taxes of the partners if losses are reported.
A partnership is a business structure for a company. It is a pass-through entity, which means the company itself doesn’t pay any taxes, the owners (called partners) do, via a Schedule K-1 form issued to the partners from the partnership. The partner(s) then simply reports their share of profit and loss on their individual tax return. This prevents double-taxation, something that only partners of a C Corporations face… when the corporation pays federal and state taxes as well as all individual partners on their individual tax returns. Partnerships do have state-mandated requirements, like filing annual reports and paying the required fees.
A partnership is the simplest business structure, because there is no filing done with any state agency. All you need is a notarized partnership agreement in the partnership’s possession.
There are a few limitations, though. Partners can pay more in federal taxes on earnings that the shareholders of an S Corporation. Since the partnership’s earnings are subject to self-employment taxes, the profits reported on the Schedule K-1 are taxed at the partner’s personal tax rate (which varies from 12% to 37%) plus an additional 15.3% in self-employment taxes. A shareholder of an S Corporation only pays the tax at their personal rate; there is no self-employment tax imposed. So, for profits, partners of partnerships pay 15.3% more than shareholders of S Corporations in federal taxes.
Not making money and showing loses? No income, no problem! Both partnership partners and S Corp shareholders can offset all ordinary personal income with their business losses… This reduces the adjusted gross income (AGI) of the partners or shareholders, which reduces their taxable income and their tax. That leads directly to a lower tax due or an increased refund.
Partnerships, LLCs and S Corps make your expenses less expensive. A cell phone an excellent example of this. A cell phone plan that costs $100 a month is a $100 per-month expense if you run a business. If you are a W-2 employee working for a company, you are paying for that cell phone with post-tax money, so you actually need to earn $125 to cover that bill.
Essentially, for every $1,000 in business-related expenses you’re paying $250 more as a W-2 employee than you would be if you started a partnership. These expenses include everything it takes to run your business; your cell phone, internet, meals, travel, electricity, and even rent.
Partnerships, LLCs and S Corps are all separate legal entities. This protects you and your personal assets. The partnership is solely liable for its debts and obligations; the owner of the partnership is not. If the partnership were to be sued by a creditor, that creditor could only go after the partnership’s assets and not the owner’s.