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The Flow-Through Principle
A partnership is a "flow-through" entity. This means income is taxed only once at the partner level, not at the business level. This interactive guide will walk you through the key concepts of partnership taxation.
1. Partnership Earns Income
The business generates income and has expenses.
2. Informational Return (Form 1065)
The partnership files a return to report its finances but pays no tax.
3. Partners Pay Tax (Schedule K-1)
Income "flows through" to partners, who report it on their personal returns.
Calculating Partnership Income
A partnership's financial activity is sorted into two buckets: items that make up 'Ordinary Business Income' and 'Separately Stated Items'. This calculator shows how different items are classified and passed to partners. Adjust the values to see the impact.
Income & Expense Calculator
Results
Ordinary Business Income
$140,000
Separately Stated Items (passed to partners)
- Dividend Income: $8,000
- Section 179 Deduction: ($30,000)
- Charitable Contributions: ($20,000)
Calculating a Partner's Tax Basis
A partner's tax basis represents their economic investment in the partnership. It's crucial for determining the taxability of distributions and the deductibility of losses. Basis is dynamic; it increases with income and contributions, and decreases with losses and distributions.
Partner Basis Calculator (50% Partner)
Basis Calculation Breakdown
Ending Tax Basis
$95,500
Note: A partner's share of losses is only deductible up to their tax basis. Any excess loss is suspended and carried forward.
Key Deductions & Costs
QBI Deduction (Sec 199A)
Partners may be able to take a personal deduction of up to 20% of their Qualified Business Income (QBI) that flows through from the partnership. This is a significant below-the-line deduction that reduces overall tax liability.
Organizational & Start-up Costs
A partnership can elect to deduct up to $5,000 of organizational costs and $5,000 of start-up costs. Any excess costs are amortized (deducted gradually) over 180 months.
Syndication Costs
Costs for promoting and selling partnership interests (e.g., printing offering materials) are not deductible or amortizable.
What About LLCs?
A Limited Liability Company (LLC) is a legal structure that protects its owners ("members") from personal liability for business debts. For tax purposes, the IRS doesn't have a separate category for LLCs; instead, an LLC's tax treatment depends on the number of members and their choices.
Single-Member LLC
By default, treated as a...
(Taxed as a Sole Proprietorship)
Multi-Member LLC
By default, treated as a...
(Files Form 1065)
The "Check-the-Box" Election
An LLC can file Form 8832 to elect to be taxed as a C Corporation instead of its default classification. This provides flexibility but subjects the entity to corporate tax rules.