IRS Red Flags from Partnerships


There are two types of partnerships, both of which will report on the same federal form: Form 1065. The two types of partnerships are general partnerships and limited partnerships (LP).

shake-hands

You don’t see many general partnerships these days, or at least I hope you don’t! That’s because the general partnership doesn’t provide any asset protection at all. Each partner has full liability for anything the company does, he/she does and his/her partner does.

The limited partnership has two classes of partner: general partners and limited partners. There must be at least one of each in order for a partnership to exist. The general partner has full liability and operates the company. The limited partner only has risk equal to the amount he/she has invested. And the limited partner can not manage the company.

orchesta

An LLC that has more than one owner (a multi-member LLC) is taxed like a partnership unless a tax election is made to be taxed in another form like an S Corporation or C Corporation. An LLC has two different forms of management: member-manager and manager-managed. The LLC files on Form 1065 unless it’s a single member LLC or has elected to be taxed as an S or C Corporation.

There are a couple of things to be concerned about. First, if there is a loss, is it passive, non passive, active or material?

If you have a business, there is still a possibility that the loss may be passive, especially if your only ownership is as a limited partner. New regulations released by the IRS at the end of 2011 state that if you hold a business or investments inside a partnership and your only ownership share is as a limited partner, you have passive income/expense. If you want to convert that to nonpassive, active or material, you’ll need to additionally pick up a general partnership share and become active in management.

business-man

If you have an LLC, the same issue occurs if the LLC is formed as member-managed and you haven’t been named as a manager for the LLC. In that case, it’s passive. Best practice is to change this to a manager-managed and make yourself one of the named managers.

If you’ve got a limited partnership or member-managed LLC with a loss, expect some IRS scrutiny. That’s a big red flag right now.


Tags:

3 Comments so far:


On May 16th, 2012 | 1:58 pm
JM said:

Can an LLC with two corporate members, file to be taxed as an S corp, and if they do would they file BOTH IRS form 8832 and 2553. the instructions for 2553 say that only an LLC with individual members may use that form. What is the difference between the LLC filing 1065 partnership vs 1120S S-corp; they both require a K-1 to the partners. What is the tax/other advantage of electing the S-corp, if this LLC can in fact so elect with corporate members.


On May 17th, 2012 | 12:53 am
Megan Hughes said:

Hi JM,

An LLC can certainly apply to be taxed as an S Corp, even with just one Member. You would file a Form 2553. Check with your tax professional about filing the Form 2553, as we’re after March 15th, there is an alternative filing procedure you need to follow to make the election retroactive to January 1, 2012.

The biggest difference is the ability to now run a payroll (can’t do that effectively in an LLC run as a 1065 partnership) and stream your income into payroll and distribution. Depending on what the business does, this can be a good thing … or not - again, it depends on the business activities.

Moving into an S Corp tax structure can also impact you if you are distributing assets out to the Members. There could be some unexpected tax consequences here, so check with your advisor to make sure the election makes sense for you.


On January 13th, 2013 | 3:32 pm
Ron said:

My partner and myself established an LLC and purchased a property in Louisiana in early 2012. I wanted to take a corp tax structure but filed the wrong form and wound up electing a S-corp tax structure. I actually wanted to elect a C-corp tax structure. Since we took some heavy expenses with this property, I would like to keep the losses in the LLC and not distribute them. Is there a way I can take the C-corp structure even though the S-corp structure was granted by the IRS? Also, Is it a good idea to have an LLC that has property to be taxed under C-corp election? Thanks in advance



Leave a Reply

Will not be published


+ nine = 10