Partnerships are a very popular choice of entity for many small businesses. There are multiple types of partnerships including a limited liability 
company (LLC), general partnership, limited partnership, limited liability limited partnership (LLLP) and others. The article below has been drafted by a Denver small business attorney at The McGuire Law Firm to discuss a few issues about partnerships in terms of choice of entity. Please feel free to contact our law firm to speak with a business attorney and discuss any questions you may have.
Partnerships are not taxable entities under Internal Revenue Code Section 701. A partnership will file a Form 1065, which is the partnership income tax return and the income and losses of the partnership are passed through to the individual partners and reported on a K-1. Thus, a partner may have to claim income on their 1040 individual income tax return even if there was no actual distribution of cash to the partner. Under Internal Revenue Code Section 702(b), the character of income or loss is determined at the partnership level.
Not only do partnerships provide a lot of flexibility regarding their governance, a partnership may also allocate income and losses amount partners in any manner given the allocations have substantial economic effect under Internal Revenue Code Section 704(b). Thus, through special allocations and adjusting sharing ratios for profits and losses, the partnership agreement or operating agreement can be drafted to meet the needs of the partners.
A partner’s ability to deduct the losses of a partnership will be limited by the partner’s basis in the partnership interest. Excess losses can be carried forward and allowed to the extent of later increases in the partner’s basis. Capital contributions and the distributive share of partnership income will increase a partner’s basis, and distributions and loss allocations will reduce a partner’s basis. A partner’s basis will also include their share of partnership liabilities under Internal Revenue Code Section 752 and thus using the partnership format to hold leveraged properties such as real estate can be a benefit.
Generally, a partnership will adopt the same taxable year as the partners owning a significant portion of the partnership. One advantage of a partnership to an S corporation is ownership. A partnership, such as an LLC, can be owned by any number or individuals or business entities. Whereas an S corporation is limited in the number of shareholders and generally all shareholders must be individuals. A partnership can be publicly traded, I actually believe the Boston Celtics were (and still may be) a publicly traded partnership. If the partnership is publicly traded (also called a master limited partnership) it would be taxed as a corporation under Internal Revenue Code section 7704.
The IRS has proposed regulations to help prevent potential abuse of corporate partners avoiding corporate level gain through a transaction with a partnership that would involve the equity interests of the corporate partner. For example, a corporate partner could contribute appreciated property to a partnership and an unrelated partner could contribute cash to the partnership. The partnership could use the cash to purchase stock in the corporate partner and upon liquidation of the partnership the corporate partner could receive its own corporate stock and thus avoid gain on the appreciated property. The proposed regulations create a deemed redemption and a deemed distribution rule.
Your choice of entity and the related implications to your business are very important. A Denver business attorney at The McGuire Law Firm can assist you in making these decisions and other business related issues.
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