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What is a partnership and how is it taxed in USA

3rd Oct 2023

A partnership is an arrangement where parties, known as business partners, agree to cooperate in order to advance their mutual interests.

The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations. Organizations may partner to increase the likelihood of each achieving their mission and to amplify their reach. A partnership may result in issuing and holding equity or may be only governed by a contract.

Partnership agreements

A partnership agreement is an internal business contract that outlines specific business practices for the partners of a company. This document helps establish rules for how the partners will manage business responsibilities, ownership, investments, profits or losses, and company management. While the word partners often refers to two people, in this context there's no limit to how many partners can form a business partnership.

Partnership agreements go by different names depending on the state and industry in which they're formed.

Partnership agreements help answer - "What happens if..." questions before they come up in practice to ensure the company runs smoothly. The three main types of partnership agreements are:

  • General: In a general partnership, all partners equally share liabilities, profits, and assets.
  • Limited: Limited partnerships protect partners who do not contribute capital equally. This way, the partner or partners who contribute the most money or assets earn the most profit and take on the most liability, while partners who contribute less in capital or assets earn less in profits and carry less liability.
  • Limited liability: Limited liability partnerships function much the same as general partnerships, but give the partners limited personal liability while maintaining equal shares of the company and its profits.

Partnership agreements help establish clear boundaries and expectations regardless of whether your partnership is general, limited or limited liability.

Tax considerations for partnerships

General partnerships, limited partnerships and limited liability partnerships are all taxed the same. No tax is paid by the partnership. Form 1065 is filed with the IRS portal, as well as a Schedule K for each owner. The Schedule K lists the owner’s share of the partnership’s income, expenses, etc.

Limited liability protection

Keep in mind that general partnerships offer no liability protection to the owners. The owners are legally considered the same as the business and personal assets can therefore be considered business assets. Additionally, partners in a general partnership bear responsibility for the actions of the other partners. General partnerships are undoubtedly the easiest to set-up and have the lowest ongoing costs, but they also create the highest risk for the partners.

However, it can still be rather difficult to file a tax return by yourself. You can always contact our tax advisor with any questions.

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