Does a Partnership Pay Taxes? An Overview of Tax Rules

A business partnership is a common structure where two or more individuals or entities agree to share in the profits or losses of a business. Many people wonder if the partnership itself pays income taxes, similar to a corporation. Generally, for federal income tax purposes, the partnership entity does not directly pay income tax on its profits.

Understanding Pass-Through Taxation

Partnerships are recognized as “pass-through” entities for federal income tax purposes. This means the business’s income, losses, deductions, and credits are not taxed at the partnership level. Instead, these financial items flow directly through to the individual partners. Each partner is responsible for reporting their allocated share of these items on their personal income tax return.

This structure ensures that business income is taxed only once, at the individual partner’s tax rate, rather than being taxed first at the entity level and again when distributed to owners, which is known as double taxation. Therefore, while the partnership generates income, the tax liability for that income rests solely with the partners.

Partner-Level Tax Implications

Partners receive a Schedule K-1 (Form 1065, U.S. Return of Partnership Income) from the partnership, which details their share of the entity’s financial results. This document provides specific figures such as their portion of the ordinary business income or loss, guaranteed payments, and any distributions received. The Schedule K-1 also reports other income, deductions, and credits that flow through to the partner. Partners use this information from their Schedule K-1 to report their share of the partnership’s income or loss on their individual income tax return, typically Form 1040.

Partnership income is generally subject to self-employment tax, which covers Social Security and Medicare taxes. General partners are typically subject to self-employment tax on their distributive share of partnership income, and limited partners may also be subject to it if they actively participate in the business. Losses passed through to partners can offset other income, but their deductibility is often limited by the partner’s basis in the partnership interest and their at-risk amount, preventing deductions exceeding their investment or liability.

Partnership Information Reporting Requirements

Partnerships do not pay federal income tax, but they still have an annual filing obligation with the Internal Revenue Service (IRS). They are required to file Form 1065, U.S. Return of Partnership Income, each year. This form serves as an information return, detailing the partnership’s overall financial performance, including its gross income, deductions, gains, and losses for the tax year.

The primary purpose of Form 1065 is to provide the IRS with comprehensive financial information about the partnership. This allows the IRS to verify that individual partners correctly report their share of income or loss on their personal tax returns, which is derived from the Schedule K-1s issued by the partnership. For calendar-year partnerships, the filing deadline for Form 1065 is March 15th of the following year. Partnerships can request an extension to file for an additional six months by filing Form 7004.

Other Taxes Partnerships Might Face

While partnerships have pass-through status for federal income tax, they may still be responsible for several other types of taxes. If a partnership has employees, it must withhold and pay employment taxes. These include Social Security and Medicare taxes, as well as federal unemployment tax (FUTA) and state unemployment tax (SUTA).

Partnerships are also subject to various excise taxes, which are taxes on specific goods, services, or activities. Examples include taxes on fuel, certain environmental taxes, or taxes on specific transactions. Additionally, partnerships face state and local tax obligations, which can vary widely by jurisdiction. These can include annual registration fees, gross receipts taxes, or specific entity-level taxes that are not federal income taxes. If the partnership sells goods or services that are subject to sales tax, it is responsible for collecting these taxes from customers and remitting them to the appropriate state or local tax authorities.