Limited liability partnerships (LLPs) have gained popularity among business professionals, particularly lawyers, due to their unique business structure. While LLPs may not offer the same level of liability protection as limited liability companies (LLCs) in certain states, they do provide significant tax advantages.
Choice of Tax Election
Unlike LLCs, the Internal Revenue Service (IRS) does not recognize LLCs as a tax classification. Therefore, LLC business owners must determine whether they will be taxed as a sole proprietor, partnership, or corporation. However, partnerships cannot operate as sole proprietors. Instead, they have the option to choose between being taxed as an S corporation or a C corporation. Members of an S corporation typically receive a salary from the company, and their taxes are paid through their personal income tax Form 1040, similar to a traditional job. On the other hand, C corporations are usually large, publicly held companies that file business tax returns.
Pass Through Tax
One of the significant advantages of limited liability partnerships is the ability to pass profits or losses directly to individual tax returns. This simplifies the tax process for small businesses and reduces paperwork compared to filing as a corporation. Partnerships that wish to pay their business taxes on their individual returns are required to file Form 1065 and Schedule K-1.
In general, partnerships distribute profits and losses based on the proportion of ownership among members. For instance, if member A owns 55 percent and member B owns 45 percent, they would each receive their respective percentage of the profits. However, partnerships have the flexibility to modify the distribution of profits and losses through special allocations. It is advisable for partnerships to consult with a tax professional before implementing special allocations, as the IRS closely scrutinizes and may reject such arrangements.
In conclusion, limited liability partnerships offer significant tax benefits to business professionals, particularly lawyers. The choice of tax election, pass-through tax treatment, and the ability to make special allocations provide flexibility and simplicity in tax management. However, it is crucial for partnerships to seek professional advice to ensure compliance with IRS regulations and maximize the advantages of the LLP structure.