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Is LLC and partnership taxation something new to you? Perhaps you have worked in this area for years but need a quick review of the fundamental concepts? If the answer is yes, this course is for you. Build a foundation of knowledge or freshen up your skills. This course addresses the tax consequences of the most common transactions engaged in by LLCs and partnerships – from formation of the entity to the reporting and allocation of partnership/LLC income or loss to distributions and compensatory payments to partners or LLC members.
Develop a level of comfort with the basic conceptual framework underlying partnership and LLC taxation, with an emphasis on explaining the tax consequences associated with issues that are most frequently confronted by tax practitioners.
Objectives:Prerequisite: None
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Overview – Basic Tax Structure for Partnerships/LLCs
Learning Objectives
After completing this chapter, you should be able to
What Is a Partnership for Federal Income Tax Purposes?
For tax purposes, a partnership exists when two or more taxpayers join together, without incorporating, to carry on business or investment activities for their mutual (or “joint”) benefit. Partnerships can be used to conduct active businesses or to carry on investment activities.
Moreover, partners can choose to participate actively in partnership operations, or merely to play
the role of passive investors, content to share in the profits (or losses) derived from partnership
operations while playing no active role in day-to-day management activities. The primary
strength of the partnership as a vehicle for conducting business is its flexibility. Partners can, for
example, agree to share differently in the risks and rewards associated with partnership business
activity. Yet, the partnership can still provide limited exposure to business risks for certain of its
partners (e.g., limited partners), providing the best of both worlds: 1) highly flexible
arrangements for sharing in the risks and rewards of business activities and 2) limited liability for
members. Moreover, unlike corporations, partnership income is only subject to one layer of tax –
imposed at the partner level. For these reasons, partnerships are the preferred form of
organization for a wide variety of business activities.
Partnerships vs. Other Entities
Legal Protection
There are several types of partnerships, each with different levels of liability protection for their
partners. The first, and most basic, type of partnership is the general partnership. In a general
partnership, all partners participate in management of the partnership, and all partners have the
legal authority to enter into binding legal relationships on behalf of the partnership. Thus, for
example, if a law firm were organized as a general partnership, each of its partners would have
the authority to enter into attorney-client relationships on behalf of the firm. Each of the firm’s
clients, even if they only deal with one attorney, are represented by the partnership, rather than
by an individual attorney. The downside to this arrangement is that claims against the firm, even
if due to the actions of only one partner, can be enforced against any and all partners of that firm,
to the extent the partnership’s assets are insufficient to satisfy the claim.
Example 1-1
In 1990, Laventhol & Horwath, then the eighth largest accounting firm in the United
States, filed for bankruptcy protection under pressure from several lawsuits stemming
from the failure of many of its audit clients. Like all accounting firms at the time, the firm
was organized as a general partnership. The firm eventually dissolved, but its partners
remained responsible for damage assessments awarded to claimants against the firm.
Most of these partners had not been personally involved in the engagements actually targeted in the various lawsuits. Nonetheless, in addition to losing their “jobs,” each of the partners was left with personal responsibility for thousands of dollars of partnership liabilities stemming from the lawsuits that drove the firm out of business. According to published reports, these liabilities generally exceeded the personal assets of most of the partners, meaning that many partners faced the prospect of personal bankruptcy following dissolution of the firm.
Due to concerns about partner liability, it can be very difficult to attract investment capital to businesses organized as general partnerships. Moreover, there are many activities in which it is neither necessary nor desirable for all partners to be involved in management of the partnership or its affairs. For example, partnerships are often used to raise capital to purchase real estate (office buildings, apartment complexes, etc.), or to drill oil and/or gas wells. These activities require large amounts of money, but do not necessarily require the input of each partner in deciding which properties to acquire or where to drill for oil and gas. Organization of the operating or drilling companies as corporations would alleviate concerns over liability and participation in management, but would raise new concerns over double taxation and lack of flexibility. Limited partnerships are designed to accommodate the business needs of these activities while still allowing them to be conducted in partnership form.
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