Partnerships and multi-member LLCs can cause a lot of confusion around taxes. As we explore everything you need to know about partnership taxes, please keep this fundamental rule in mind:
LLC partnership profits passed through to each member based on the LLC’s partnership agreement. The partnership entity typically pays no tax, while its' members do.
Simply put: we will be learning how your LLC partnership income affects your personal taxes, because of how this income passes through to you as a member. Well also look at home much tax you’ll owe on this income and how you’ll handle reporting it to the IRS. Free free to jump ahead to the tax rates here.
How LLC Partnership Taxes Work
As we’ve discussed, LLC partnerships are pass through entities that will add self employment income to you as a taxpayer. Each active member of the partnership pays both federal self employment and income taxes on their share of profits. The portion of the profits you’re entitled to get is called your “distributive share” and is defined by your partnership agreement.
Partnership Agreements define each partner’s portion of the profits and losses, also know as their distributive share. Standard LLCs are very flexible entities and can set special rules about how exactly they’ll distribute profits to their members. So if you want to distribute your profits in a way that’s not proportional to ownership you can define a “special allocation”. When adding special allocations to your partnership agreement be sure to follow IRS rules and work with a tax attorney.
Profits Are Always Taxed
Remember your “distributive share” of the partnership income will always get taxed. This comes into play when you are wanting to keep profits in the business. Those funds will still get taxed as though you had paid them to each partner as their income.
Tax Rates for LLC Partnerships
|Share of Income||Effective Tax Rate|
|$1,000,000 (no QBI)||40%|
LLC member’s of a partnership pass through their income to their personal taxes. In this case it’s a single filer, that is only earning self employment income. We've applied the deductions for self employment, full 20% QBI (except where noted), and the standard deduction. You’ll likely be able to claim other deductions based on your situation. So your actual tax rates will likely differ from the above. Please work with your accountant to learn your real effective tax rate.
Shareholders Tax Rates
Some members of your partnership could be considered “Limited Partners” or what most of us would call a shareholder. Their tax rates will generally be far lower than the rates shown above. For these members you can use the relevant long term capital gains bracket as a tax rate.
Why To Be Taxed As a Partnership
LLCs with multiple members start as partnerships for tax purposes, which some businesses actually prefer. Reasons for this are: easy setup, reduced upkeep, and supporting complex ownership requirements. Other tax classifications such as S Corps can take more setup, upkeep, and need a much more simple ownership structure than partnerships do.
Businesses taxed as partnerships can also be easier businesses to sell than S Corps. Partnerships are more flexible in terms of who and what can own their shares; S Corps prohibit ownership by other LLCs for instance. Lastly, you can’t overlook the simple fact that having multiple members makes selling your share of the business far more realistic. Your partners do after all know how your business works!
Disadvantages of a Partnership
Because your LLC is taxed as a partnership you have flexible ownership, but you forgo the tax savings of the S Corp. S Corps are a powerful tax strategy every LLC can consider, but have their own disadvantages. Please use our S Corp tax savings calculator to see if you and your partners can consider this new tax classification.
By adding your tax details and calculating your estimated savings with our tool you’ll get state-level detail on how much you could be saving each year. You’ll need to divide the savings found among all the partners of your LLC. Please also research the important trade offs S Corps are subject to, before making your decision.
How to Become a Partnership
According to the IRS: “A partnership is the relationship existing between two or more persons who join to carry on a trade or business.” Basically if you’re working with someone on a joint business venture the IRS automatically considers you a partnership, even without you requesting it! It’s very similar for LLCs: you’ll automatically be taxed as a partnership when you and your fellow member(s) incorporate your LLC in your state.
Tax Class vs Legal Entity
LLC partnerships can be thought of in 2 parts: the tax classification (partnership) and the legal entity (LLC). That tax classification, or how the IRS treats you, can be changed and still keep your LLC intact.
When you have multiple members operating the LLC: you’ll be considered a partnership for tax purposes by default. The exception to this is if your LLC specifically asked for a different tax classification. You can change your LLC’s tax classification to either a C Corp or an S Corp if you and your fellow members want different tax rules to apply to your business.
When Are Partnership Tax Filings Due?
The following are federal filing requirements for Multi-Member LLCs and partnerships. They do not include state filings, which you may be required to add to the following:
|Form 1065||March 15th|
|Schedule K-1||April 15th|
|Schedule SE||April 15th|
|1040-ES (1st Quarter)||April 15th|
|1040-ES (2nd Quarter)||June 15th|
|1040-ES (3rd Quarter)||September 15th|
|1040-ES (4th Quarter)||January 15th (following year)|
Form 1065 is a single information return filed for the entire partnership, it does not require paying taxes. The other forms are required for each partner actively involved in the business and may result in taxes owed.
Partnership Late Filing Penalties
The late filing penalty for a 1065 Partnership tax return is $195 dollars per partner, per month, for up to 12 months. For your quarterly estimated tax payments penalties are around 5% per month of the tax balance owed and up to 25% of the total balance owed. You may find our ultimate guide to self employment taxes helpful for calculating and filing these penalties.
You’ve learned a lot about how your LLC partnership will be paying taxes in this guide. You’ve also learned what your filing requirements will be and when they’ll come due. Most importantly you’ve been given an idea of how much you’ll be paying in federal taxes.
While I’m not intending to give you a highly accurate picture for your total taxes, you can consider these tax rates when you’re choosing how much you’ll ultimately set aside for your quarterly estimated payments. Estimated payments can vary a lot depending on your situation, so if you want a much more accurate idea please speak with an accountant or CPA.
Since you’ll probably be paying the dreaded self employment tax, please check out our Ultimate Guide to Self Employment Taxes. It’s packed with ideas for you and your partners to limit and avoid those expensive taxes.