Ensuring Tax Compliance for Your Partnership or LLC
Posted by Kerry Roets on September 16, 2024
When drafting partnership or LLC operating agreements, addressing key tax considerations is crucial, especially for multi-member LLCs treated as partnerships for tax purposes. Below are essential tax issues to include in your agreement to ensure compliance with federal tax laws.
Guaranteed Payments to Partners
Guaranteed payments are those made by a partnership to a partner for services or the use of capital, regardless of partnership income. Special tax rules apply, so it’s vital to outline these payments in the agreement. The partnership can deduct these payments when they’re paid or accrued, and partners must report them as ordinary income, subject to current tax rates. Even if the payment is received in a later tax year, the partner must recognize the income in the year the partnership deducts the payment.
Tax Basis and Partnership Liabilities
Partners receive additional tax basis in their partnership interest based on their share of the entity’s liabilities, which can be advantageous for deducting passed-through losses. The agreement should account for the rules governing recourse and nonrecourse liabilities, as they affect the classification and tax treatment of liabilities.
Classifying Payments to Retired Partners
When a partner exits, payments made in liquidation of their interest are subject to specific tax rules. Payments in exchange for the retired partner’s share of partnership property are treated as ordinary distributions, potentially triggering taxable gain. Other payments are classified as either guaranteed payments (if not tied to partnership income) or ordinary distributive shares of income (if tied to partnership income). These payments are often subject to self-employment tax, and the partnership agreement should clearly define how such payments are classified.
Additional Provisions to Consider
A well-drafted partnership agreement can help manage various potential issues. Key provisions to consider include:
- A buy-sell agreement for partner exits
- A noncompete agreement
- Terms for handling divorce, bankruptcy, or death of a partner, including how buyout payments will be calculated and paid if an interest is transferred to an ex-spouse or inherited.
Addressing Potential Liabilities
It’s essential to tackle tax issues upfront when structuring a partnership deal. Contact us to ensure your agreement is properly drafted to minimize tax liabilities and remain compliant with the law.
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Kerry joined Lumsden McCormick with over 10 years of experience in areas of business tax and cost segregation along with tax compliance for individuals. Her experience includes real estate for hospitality, multifamily housing, and commercial properties; historic tax credits; partnerships; and private equity and family wealth.