A partnership consists of more than one business owner; it comes into being whenever business takes place between parties, making them “partners”. A “partner” does not need to be an individual. Partners can be corporations, trusts, or other partnerships. Partners take on profits, losses and liabilities together, and will generally create a written partnership agreement that clarifies their relationship. It is important to keep in mind that a written agreement is not required by the law to find that a partnership exists — actions alone can suffice. As for tax purposes, a partnership is considered a “pass-through” entity because taxes pass through to the owners on their personal tax returns. Each owner must report his or her percentage share of income on the individual form 1040 for federal income taxes. Partners are not considered employees of the partnership; they are treated as self-employed, so each partner will be responsible for self-employment tax. If a partnership has employees, the business must pay employment taxes. This includes withholding and reporting federal and state income taxes, paying and reporting social security and Medicare taxes, worker’s compensation taxes, and unemployment taxes. If the partnership owns real property, property taxes will also be required. Finally, partnerships are required to pay state sales taxes and excise taxes.
Benefits of a Partnership:
- A partnership is easy to start and allows business profits and losses to be reported on the individual tax returns of each owner.
- Start-up paperwork and legal necessities are also at a minimum, as most states onlyencourage the drafting of a partnership agreement. Despite this, it is important to look into the required licenses and certificates when forming a partnership.
- Finally, in a partnership you can capitalize on the managerial and financial strengths of each individual partner.
Detriments of a Partnership:
- Partners have unlimited personal liability for the debts and obligations of the company.
- Additionally, each partner can bind the company to outside obligations without the approval or permission of the other partners. Therefore, one partner’s decision can leave every other partner’s personal property vulnerable should a lawsuit result in an unfavorable outcome. This divided authority can also cause internal disputes.
- Finally, without advanced planning, the partnership can fall apart very quickly; the death of a partner terminates the business arrangement.
Congress has clarified that all corporations are divided into two groups: S Corporations that fall under IRS revenue code subchapter S; and C Corporations, which encompass all other corporations. Your first step in creating an S Corporation (“S Corp”) is to form a traditional corporation. Next, you must file a special form (form 2553) with the IRS, along with any other local state documentation. S Corp status is effective for a tax year if form 2553 is filed: (a) any time during the previous tax year, or (b) by the 15th day of the 3rdmonth of the tax year to which the election is to apply. An S Corp is similar to a traditional corporation with partnership-like traits. Utah’s S Corps are for those who desire the limited liability and formal structure of a corporation, but can’t give up pass-through taxation. Your business must meet S Corp qualifications and all shareholders must agree to S Corp status. An S Corp is generally treated like a partnership for federal income tax purposes. It files an “information” tax return to report its income and expenses, and is not separately taxed as a traditional corporation. Income and expenses of an S Corp “flow through” to the shareholders in proportion to their share holdings, and profits are taxed to the shareholders at their individual tax rates.
Benefits of an S Corporation:
- One of the primary advantages of being treated as an S Corp is the pass-through taxation described above. There is only one tax at the individual shareholder level.
- This is in contrast to a corporation where taxation occursfirst on the company’s income level, then again at the individual owners’ distributions out of that income. Shareholders therefore enjoy “the best of both worlds” with an S Corp: they have the pass-through taxation benefits of a simple partnership, but the limited liability and asset protection of a corporation.
Detriments of an S Corporation:
- With an S Corp you cannot have an unlimited number of members – shareholders are restricted to a designated number. In Utah the maximum is 35 shareholders.
- There is also a possibility that the IRS may look passed your subchapter S status for tax purposes if there is only one shareholder. This is more likely to occur when formalities are not adhered to – so remember, always stick to corporate formalities, they are worth the trouble!
- Finally, you are restricted to just one class of stock with an S Corp.
Free Consultation with a Business Lawyer
If you are here, you probably have a business law issue you need help with, call Ascent Law for your free business law consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506