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Choosing between a partnership and corporation is a big decision, but the IRS tends to favor partnerships with more tax benefits. This doesn’t mean there aren’t downsides to partnerships, though.
Both the positives and negatives are disclosed below so you can decide for yourself which business type is right for you.
The Tax Benefits of Partnerships
- Pass-through taxation
- You can transfer assets tax-free
- You can take advantage of basis from partnership debts
- You may be eligible to write off partnership losses
- You may be eligible for special tax allocations
- You can take advantage of basis step-up for purchased interests
- You may be able to use the Section 199A tax deduction
The Downsides of Partnerships
It’s only fair to disclose the downsides of partnerships too so you are fully aware of your options.
- You’re subject to self-employment tax
- The sales rules aren’t transparent
- The fringe benefit tax rules aren’t fair
- The 704(c) tax allocation rules are difficult to navigate
What About Limited Partnerships?
There’s another option – limited partnerships.
They have the same tax treatment as partnerships including the benefits I mentioned earlier. However, limited partnerships don’t have the same liabilities as a general partnership. You can’t lose more than your original investment unless you’re a party that guaranteed the partnership’s debt. Limited partnerships also have a tax advantage when it comes to self-employment taxes.
Of course, though, there are downsides to limited partnerships including:
- There’s no basis from partnership liabilities
- You need someone to be the general partner
- You may not have the same liability protection
Before you sign a any partnership agreement, consider the following:
- Make sure there is a solid buy-sell agreement in place
- Agree on how the separation would work including if there is a death, divorce, or bankruptcy of one partner
- Create a non-compete agreement
- Detail how you’ll calculate and distribute proceeds
- Discuss how you’ll handle tax allocations
If you’d like to learn more about how to choose the right business structure for your business idea, contact us today.