Published on: October 28, 2020 Last modified: November 23, 2020

How Members of an LLC Partnership Are Taxed

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    Small business operations are often more complex than what people can see on the surface. Many people assume that easy-going operations like coffee shops or small clothing stores don’t have to worry about complicated paperwork and arrangements. The truth, however, is that small business operations can prove extremely complicated.

    As a small business owner, especially if you’re running a limited liability company (LLC), LLC partnership, or considering forming one, you may want to know more about how to handle taxes and what issues you can expect. 

    LLC Partnerships and Business Partnerships

    An LLC is a small business structure that protects the owner of the business, or sole proprietor, from personal liability because of the business’s finances. In a partnership, two or more entities join together to expand their operations and experience benefits on their personal tax returns. Both business partners share the liabilities and benefits. 

    members of a llc forming an agreement where they will eventually pay llc partnership taxes

    An LLC partnership is a formal business arrangement in which two or more partners enter into business together. Taxes pass through the business structure, rather than the partners getting taxed individually on the business’s initial profits. 

    The Pass-Through Method

    LLC partnerships can be taxed as either a partnership or a corporation. If an LLC gets taxed as a corporate entity, it receives the same favorable tax rates the Internal Revenue Service (IRS) gives larger corporations. Here are a few facts:

    • Corporate tax rates frequently do not create the same burden as personal tax rates, which can decrease the costs that you and your partners see when you pay your taxes each year. 
    • Corporate taxation also means that you can retain profits within the business to fund business projects. 
    • On the other hand, many LLCs opt to use the pass-through method. 
    • Under the pass-through method of LLC taxation, profits are taxed only at the members’ level of taxation, not at corporate levels. 
    • This can help avoid double taxation as profits move through the business and to the private individuals connected with it. 

    Using the pass-through method, profits and losses “pass through” the business, moving on to the members of the partnership instead. Profits and losses thus get managed at a personal level, which can help prevent double taxation of business earnings.

    How to File Taxes as an LLC Partnership

    As an LLC partnership, you will need to follow several steps as you prepare your taxes each year. These include:

    • Filing IRS Form 1065.
    • Each member showing record of its credits and losses based on its percentage of the business on Schedule K-1 (1065), Partner’s Share of Income, Deductions, Credits, etc.
    • Planning to pay a self-employment tax on your share of the partnership earnings.

    The Tax Implications of Being Taxed as an LLC Partnership

    Before deciding that you want your business entity to be taxed as an LLC partnership, it’s important to consider the tax implications. A close look at the following can help you determine whether this method of taxation works for your partnership. 

    Pros

    • The tax rate depends on the total income for the owner or owners, not on corporate tax rates. 
    • At some levels of income, this can result in lower federal income tax returns for a single-owner LLCs or owners. 
    • You are not subject to double taxation, as corporation owners’ business income may be.
    • Profits and losses flow directly to the members

    Cons

    • Some LLC owners may opt for corporate taxation, rather than partnership taxation, because of the potential drawbacks. 
    • You may find that corporate taxation is the most effective choice for your LLC, especially if you have a large business structure or want to keep your profits within the business over the first several years. 
    • At some levels, corporate taxation proves less expensive than partnership taxation
    • You cannot keep profits within the business to fund future projects
    • You must equally pay taxes even if you do not receive an immediate distribution from the business, whereas corporate taxation requires the payment of personal taxes only when you receive your share of the profits

    Before deciding on the type of taxation you want for your LLC, make sure you and your partners carefully consider the benefits and drawbacks. A full understanding of your available options can make it easier to move forward in a way that works for all parties. 

    The Benefits of Working With a Trusted Tax Advisor

    There are many benefits to working with a trusted tax advisor or CPA, including that: 

    certified accountant doing llc partnership taxes
    • You get the process right from filling out all your IRS forms as an LLC partnership to making sure you claim the right income, deductions, or losses. 
    • This means you can avoid much of the stress associated with managing your taxes each year as well as potential challenges down the road if you misreport your income or deductions. 
    • A tax advisor can help you take all the steps necessary to reduce the odds of a costly audit and ensure you have all your paperwork in order if you do experience one down the road. 
    • Many LLC partnerships also find that working with a tax advisor helps them answer vital questions about how they can decrease their tax burden. 

    Contact the Tax Experts Today

    Whether you recently entered into an LLC partnership or you and your partners have worked together for years, a tax advisor can bring many advantages to the table. Contact Silver Tax Group today for legal advice about your LLC partnership return questions, or to speak with an expert about other tax-related questions you might have.

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