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What is Partnership Taxation?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 09 December 2016
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Partnership taxation is the taxing of business partnerships. Tax law around the world is highly variable, and many nations handle partnerships in different ways. It is important to consult an attorney before preparing to make a change to the structure of a business or filing taxes on a newly reorganized company to make sure that the procedure is done correctly. The most common approach to partnership taxation is a pass-through model, where the partnership, as a legal entity, does not pay taxes, but the partners do.

No matter how the tax law is organized, partnerships must file tax declarations showing profits, losses, and movements of finances. In some nations, this information is used to determine the tax liability for the partnership, to see how much money it owes. In others, the tax return becomes the basis of income statements sent to members of the partnership, recording their profit and loss in the business, and they must include this information on their personal tax returns.

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The United States is an example of a country that uses the pass-through system for partnership taxation. Businesses often form partnerships because it can be advantageous for legal and tax reasons. Requiring financial declarations ensures that partners cannot understate their income to avoid tax liability; if a partnership had big earnings in a given year and a member claims no income, the Internal Revenue Service can consult the partnership's tax return and use it as grounds to investigate the partner for tax fraud.

Laws surrounding partnership taxation can become tricky. Before people form a partnership, they usually meet with an attorney to discuss the best kind of partnership to form from a legal perspective, and they may also discuss tax issues at the same time. The partnership's tax filings must be accurate, with complete disclosures of all financial matters, so partners receive appropriate declarations for their own tax returns. If there is a disparity like one partner making much less than the others, tax authorities will want an explanation for why that is, to determine if it is legitimate.

In a larger partnership, the business may have a full-time accountant to handle financial matters, and this person will also prepare tax forms. Other companies may bring in an accountant to take care of taxes and periodic financial filings because they cannot support an accounting staff year round. The accountant should have experience in partnership taxation to prepare returns accurately and increase tax savings for the partnership and its members.

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