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Partnerships and LLCs from a Tax Perspective

© Alinghiblue | Dreamstime.com - <a href="https://www.dreamstime.com/stock-illustration-analysis-statistic-illustration-values-graphs-orange-image43117700#res2965056">Analysis Photo</a>A partnership is not a tax-paying entity, but files an annual tax return, Form 1065, to report income, deductions, and other items. These items pass through to partners, who may be individuals, other partnerships, corporations, or other entities. Partners report their allocable share of these items on their own tax returns. As in the case of sole proprietorships, the tax statistics show that the number of partnerships (including limited liability companies that file tax returns as partnerships) is on the rise.

For 2014 (the most recent year for statistics), there were 3,611,255 million partnerships (4.4% more than in 2013), representing more than 27.7 million partners (up from 27.5 million partners the year before).

Here is some other interesting tax-related information about these filers:

  • Limited liability companies (LLCs) in the U.S. accounted for the majority (67.4%) of all partnership returns. This is the 13th consecutive year that LLCs dominated the number of partnership returns filed. The number of LLC members grew to 10.2 million (a 5.25 increase over 2013).
  • Limited partnerships represented only 11.5% of all partnerships. Nonetheless, they reported the most profits (32.2% of all returns) and the largest share of partners (44.2%).
  • Total receipts (revenue) for filers increased by 5.6% from the previous year to $7.5 trillion. Profitability was also up, increasing by 8.9%.
  • Partnerships with less than 3 partners made up 55% of all partnerships.

Which industries increased the most? The number of returns in the finance and insurance industries increased by 27.7%. Lessors of nonresidential buildings (except mini-warehouses and self-storage units) increased by 13.7%. The greatest decrease (20.2%) was for rental and leasing services and lessors of non-financial intangible assets (except copyrighted works).

Which industries do the best? While real estate is the most numerous type of partnership, the finance and insurance sector had the largest share of total net income (49.8%). All 20 industry sectors reported an increase in their assets in 2014.

Why do these statistics matter?

With the potential for serious tax reform in the coming year, what impact will any changes have on the utilization of partnerships and limited liability companies? How much do taxes impact the choice of entity for business owners?

One scholarly paper done after the Tax Reform Act of 1986 showed a shift in the choice of business entities to pass-throughs (partnerships, S corporations) where business profits were taxed at the owners’ low tax rates as compared with the rates on C corporations. Under that law, the top individual tax rate was 28% beginning in 1988. At that time, the top corporate tax rate was 34%.

For purposes of current tax reform anticipated next year, there’s discussion about dropping the top corporate rate to 15% (as Trump has suggested) or a flat 20% (as provided in the Ways and Means Blueprint). At the same time, the top individual tax rates would likely be higher. For example, under the Blueprint, the top individual tax rate would be 33%, but owners of pass-through entities would pay no more than 25% on their business income. Still, if the top tax rate on C corporations was lower than 25%, entities may opt for this form of doing business in order to save taxes.

Whether this comes to pass depends, of course, on the final tax picture, and other factors (I list 13 factors in the choice of entity in J.K. Lasser’s Small Business Taxes 2017, of which taxes are only one factor).

In my view:  Regardless of tax changes, these entities, which are creatures of state law, will continue to abound.

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