Tax Planning for Partnership

Almost every day, CPA face the task of structuring a new business for a client. This can be one of the most critical decisions the CPA is involved in-and provides with a perfect opportunity to save the client tax dollars and headaches.

To ensure that the client is making the right entity selection, one needs to be familiar with all aspects of the client's business, know that all major tax and nontax issues have been addressed, and that all possible structures have been considered.

In the past, the choice of entity required a comparative analysis of C corporations, S corporations, partnerships [including general, limited, and limited liability partnerships (LLPs)], sole proprietorships, and limited liability companies (LLCs). With today's sophisticated tax planning, however, many new businesses are structured using two or more of these entities to maximize the advantages offered by each. Entrepreneurial businesses are also frequently structured with multiple entities. Typically, the business is operated in a limited partnership with the investors as limited partners and an S corporation owned by the entrepreneur as the general partner. This partnership structure allows the flexibility to both provide priority allocations to the investors and permit disproportionate capital contributions from the general and limited partners. The limited partners are protected against liability because of their limited partner status and the general partner shareholder also has limited liability when operating as an S corporation.

1 Whether the new business operates as a single entity or is structured using multiple entities, it is important  to understand the tax and nontax advantages and problems of using each type of entity. This chapter discusses the formation of the partnership entity, how it is different from other entities, partnership variations (e.g., LLCs and LLPs), and partnership agreement drafting considerations.

Among the features of partnership taxation that differ significantly from the taxation of C corporations or S corporations are-

a. the greater ability of partners to contribute property on a tax-free basis

b. the ability, within limits, to specially allocate items of income, gain, loss, deduction, and cash flow among the partners differently from the partners' shares of capital or profits

c. the ability, in many instances, to distribute property to partners without gain recognition at either the partner or partnership level

d. the ability of partners to increase their basis in their partnership interests to reflect increases in partnership liabilities, allowing them to deduct additional partnership losses

 

e. the ability, in many cases, to liquidate with little or no tax cost

 Choosing to operate a business as a partnership or in some other form, typically a corporation, is affected by a variety of concerns, including rules specifically related to the taxation of partners and partnerships. Nontax concerns, such as limiting liability for business obligations, obtaining public equity financing, or allocating management rights in a particular way, also play a role. Other considerations not directly related to specific partnership tax rules may also have a significant tax impact.