Businesses and business assets may be held in a variety of forms and entity types including corporations, partnerships, trusts and various other iterations. Decisions on the form and structure of holding entities are commonly based on immediate functional considerations but, if used properly, may provide significant current and future tax benefits. For example, limited liability companies, limited liability partnerships and general partnerships, all governed by Subchapter K of the Internal Revenue Code, are considered to be aggregations of their partners or owners. This underlying principal provides partnership taxation with more flexibility than that offered to other business structures. Although each of the various types of partnerships and LLCs must file an annual business tax return, the business is not taxed directly. Instead, each partner or owner reports their share of the business income on their personal tax return, an arrangement that allows a maximum amount of flexibility in terms of dividing profits and subsequently maximizing tax benefits.
The starting point for understanding partnership taxation is the concept of basis. This includes the basis of each partner in the partnership entity, often referred to as the outside basis, as well as the partnership’s basis in its property, called the inside basis. Inside basis is determined by each partner’s basis in property contributed to the partnership entity at the time the contribution is made. Outside basis, which is much more complex and fluid, is governed by Internal Revenue Code 705. This portion of the IRS tax code outlines the process for determining each partner’s basis in their respective partnership interests during the life of the partnership. It begins with the adjusted basis of the property contributed to the partnership and is adjusted over the life of the partnership based on the partner’s distributive share of partnership income, gain and loss.
Partnership basis, as described above, is what ultimately determines gains and losses on the disposition of company assets and the taxation of partnership distributions. This being the case, one of the primary tax benefits of the partnership structure is the flexibility allowed for the allocation of income, gains and distributions between partners as well as that reacted to transactions that affect the basis of partnership interests and assets. Proactive tax planning opportunities often exist allowing for basis adjustments to plan for current and future income events. In addition, assets held in a partnership may allow for significant estate tax planning opportunities.
Although the flexible structuring allowed for partnerships and LLCs makes it possible for these business entities to realize some very definite tax advantages, the tax planning process involved in achieving this end is very complex. Some of areas where skilled tax professionals can assist members of partnerships and LLCs in receiving the tax benefits that are available to them are listed here although the list is, by no means, exhaustive: 1) incorporation of a partnership, 2) changes to the partnership structure, including retirement, 3) transfer of assets from one partner to another, 4) distribution of cash or capital assets and 5) dissolution of an existing partnership.
It often takes an experienced tax professional with a thorough understanding of the tax code governing partnerships and LLCs to ensure that partners and owners gain the maximum tax advantage while, at the same time, avoiding unexpected tax consequences. The experienced professionals CGT Solutions have helped many business owners save tax dollars though effective tax planning. If you are a member of a partnership or an LLC and are interested reducing your taxable income and lowering your tax rate, contact us today to receive a free, no obligation consultation.
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