Income taxation of Texas partnerships: an overview
If you are going to partner with someone in launching a new business, you may have questions about the federal income tax implications. Here is a brief overview partnership taxation principles. Because federal income taxation is such a technical subject, you would be wise to consult a qualified Conroe Texas business attorney who can advise you on the details applicable to your specific situation.
Pass through entity
A partnership is a “pass-through entity,” which means it does not pay income taxes. Nevertheless, it must file an informational return (Form 1065) reporting its profits and losses to the IRS. The partnership must also give each partner a Schedule K-1, which lays out each partner's share of the partnership's profits and losses. At the inception of the partnership, the partners should agree on how they will share profits and losses and should spell that out in their partnership agreement.
The partners report their respective shares of partnership profits on their individual returns and pay taxes on the profits at their individual rates. A partner must pay taxes on his or her share of partnership profits even if they are not distributed to the partner from the partnership.
If your partnership has operates at a loss, which sometimes happens with a new business, you may be able to deduct your share of the loss from your other income. However, the amount you can deduct could be limited by the “at risk” and/or “passive loss” rules.
The purpose of these rules is to discourage people from purposely trying to generate losses to reduce or eliminate their taxes. The passive loss rules limit losses on activities in which you do not materially participate (i.e., perform significant work). The at-risk rules limit the losses you can deduct from the partnership to the amount of your investment in it. Either one or both of these sets of rules may apply, depending on your circumstances.
Partners are considered to be self-employed, rather than employees of the partnership, and are therefore liable for self-employment taxes.
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