PARTNERSHIP TAX

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There is a variety of reasons why partnerships are attractive for tax. One of the reasons is pass-through taxation. Under the general rule, partnership itself doesn’t pay income tax at entity level, unlike C-Corporation, for example. Partnership issues Schedule K-1 to pass through information to its partners who then report it on their returns. Partnership typically is required to file informational returns to pass that information through. Another reason partnerships are attractive for tax is flexibility. 

For example, under 721(a), contributions of property by the partner to the partnership in exchange for interest in a partnership typically are no gain/loss recognition transactions under general rule. Similar tax treatment may apply at exit under the general rule unless a certain set of facts and circumstances applies. This is not the case with C-Corporations where rules are totally different.  

• Choosing the Right Structure: Help clients decide between general partnerships, limited partnerships, or LLCs, considering tax implications.
• Drafting Partnership Agreements: Advise on tax-related clauses in partnership agreements, such as profit allocation, capital accounts, and special allocations.

• Filing Returns: Guide clients in filing Form 1065 (U.S. Return of Partnership Income) and issuing Schedule K-1s to partners.
• Income Allocation: Ensure proper allocation of income, deductions, and credits among partners as per the partnership agreement and tax laws.
• Depreciation and Capitalization: Advise on depreciating assets or capitalizing expenses, especially in real estate or capital-heavy industries.

• Distributions: Ensure clients understand the tax consequences of cash or property distributions to partners.
• Sales and Exchanges of Partnership Interests: Assist with the tax impact of selling or exchanging partnership interests, including the potential for capital gains or ordinary income recognition.
• Section 754 Election: Advise on making a Section 754 election to adjust the basis of partnership property upon a transfer of interest or distribution.

• Centralized Partnership Audit Regime: Help clients navigate the rules under the Bipartisan Budget Act of 2015, which allows the IRS to assess taxes at the partnership level.
• Push-Out Elections: Discuss options for pushing out adjustments to partners in case of an IRS audit.

• Termination of Partnerships: Help with the tax-efficient dissolution of partnerships, ensuring proper distribution of assets and handling any final tax returns.
• Retirement or Buyout of Partners: Plan for the retirement of partners, including structuring buyouts to minimize tax burdens for both the partnership and the departing partner.

• Foreign Partnerships: Handle tax planning and compliance for partnerships with foreign partners or operations, including advising on withholding requirements, FATCA, and reporting on Form 8865.
• Outbound and Inbound Partnerships: Assist U.S. partnerships with foreign activities or foreign partnerships with U.S. investments, ensuring compliance with international tax laws.

Recently, rules regarding amending partnership returns have changed, and it became more complicated to change or amend certain partnership tax returns. Smaller partnerships that elect out of BBA Centralized Partnership Audit Regime are typically easier to change unlike partnerships that could not or did not elect out.  

Partnership allocations is simply a division of income, loss, gain, deductions, credits among partners. Of course, this is way more complex that. 

For example, Partner A contributes property to a partnership with 3 other partners. That property has built in gain, which means what Partner A paid for it is much less than what it is worth today. How does that built in gain get allocated among partners? Why would the other 3 partners want to take on a portion of that gain that they would later have to pay tax on? Which method should be used for allocations: traditional, remedial, curative? Similar questions may arise when this same property is sold. 

Under section 1446(a), a partnership (foreign or domestic) that has income effectively connected with a U.S. trade or business (or income treated as effectively connected) must pay a withholding tax on the effectively connected taxable income (ECTI) that is allocable to its foreign partners. In most cases, a partnership determines if a partner is a foreign partner and the partner’s tax classification based on the withholding certificate provided by the partner. The tax rate for such withholding varies depending on whether the foreign partner is a corporation, ’n which case the rate is the highest rate of tax specified in IRC 11(b). In case of foreign partners that are not corporations, the rate is the highest rate of tax specified in IRC 1. 

The withholding tax rate for effectively connected income (ECI) allocable to non-corporate foreign partners is 37%, and 21% for corporate foreign partners. 

Partnership may be required to file Forms 8804, 8805, and 8813 to pay and report section 1446 withholding tax based on effectively connected taxable income (ECTI) allocable to foreign partners (as defined in section 1446(e)). 

The partnership, or a withholding agent for the partnership, must pay the withholding tax. The partnership that must pay the withholding tax but fails to do so may be liable for the payment of the tax and any penalties and interest. 

Form 8308 Report of a Sale or Exchange of Certain Partnership Interests was recently revised and expanded to include additional information with new sections added. This form may need to be filed by the partnership as an attachment to Form 1065 when money or other property received in exchange for the partnership interest is traceable to "hot assets," like unrealized receivables or inventory items or a Sec. 751(a) exchange under Regs. Sec. 1.6050K-1.  

For tax year 2024, there is new tax form 7217 Partner's Report of Property Distributed by a Partnership applicable to distributions to partners during tax year 2024. It applies to both liquidating and non-liquidating distributions. 

Our attorney can assist with evaluating and optimizing your options.