A partnership is a business entity formed when two or more individuals or entities come together to form a business for profit. In a partnership, the individuals or entities involved are known as partners. The partners contribute capital, skills, resources, or a combination thereof to the partnership.
Partnerships are not considered separate legal entities from their owners. Instead, like sole proprietorships, the partners report the partnership’s income, deductions, and other tax items on their individual tax returns.
The partnership itself does not pay income tax since the profits and losses “pass through” to the partners. Instead, it files an informational return (Form 1065) to report the business’s financial activity and distributes Schedule K-1 to each partner, outlining their share of the partnership’s income and deductions.
Do partners in the business have to file a W-2?
No, partners in a business are not employees and are not required to file a W-2. Instead, partners are distributed a share of the profits.
Profit distribution in a partnership
The profit distribution in a partnership works according to the partnership agreement. For some businesses, the profits are distributed to the partners, for others, it’s reinvested back into the business.
The agreement outlines what percentage of the profits each partner will receive. This is agreed upon by the partners and is usually determined by the time and capital invested by each partner. Agree is the key word here. Even if each partner owns an equal share of the business, the profits may be distributed equally depending on what was agreed upon in the partnership agreement.
Taxes on profit distributions and capital reinvested
If a partner decides not to take a distribution and, instead, reinvests the profits back into the business, this does not mean that they won’t pay any income taxes. Like a sole proprietorship, the profits are still considered allocated to them even if they decide to keep it in the business.
How to file taxes as a partnership
Get an EIN
In a sole proprietorship, getting an Employer Identification Number (EIN) to do business is optional. If you want, you can choose to operate under your Social Security number. Partnerships are required to obtain an EIN from the Internal Revenue Service (IRS). The EIN is used for tax identification purposes and is necessary to file partnership tax returns. Getting an EIN only takes around 10 minutes and can be done online through the IRS website.
Partnerships must file an annual tax return using Form 1065. This return reports the partnership’s income, deductions, credits, and other relevant information. The due date for filing Form 1065 is generally March 15th, or the 15th day of the third month following the end of the partnership’s tax year. However, if the partnership requests a filing extension, the due date can be extended to September 15th. There are no tax reporting requirements through Form 1065 since the profits and losses pass through to the owners in the business.
Along with Form 1065, the partnership must provide each partner with a Schedule K-1. This schedule reports each partner’s share of the partnership’s income, deductions, credits, and other tax items. Partners use this information to report their share of the partnership’s income on their individual tax returns.
Like a sole proprietorship, partners in a business are responsible for paying for their own Social Security and Medicare taxes.
In 2023, 12.4% of your self-employment taxes goes towards Social Security taxes, on up to the first $132,900 of your income, and 2.9% of your self-employment taxes goes towards Medicare tax.
These amounts are reported on Schedule SE each year when you file your federal tax returns.
Preparing for tax payments
Like a sole proprietorship, each partner is responsible for setting aside money to pay their taxes each year.
When are taxes due for partnerships?
The tax filing for partnerships is one month earlier than the federal tax filing deadline of April 15th. Partnerships have until March 15th.
To request a filing extension, partnerships must file Form 7004 by March 15th. This extension allows the partnership an additional six months to file its tax return.
However, it’s essential to understand that while an extension grants more time to file the tax return, it does not extend the deadline for paying any tax owed. Any taxes owed by the partnership should be paid by the original due date (March 15th) to avoid potential penalties and interest.