What Is the Tax Benefit of Forming a Limited Liability Partnership?
Business partners forming a new company may owe considerably less money to the Internal Revenue Service (IRS) if they register the partnership as a limited liability partnership, or LLP, rather than structuring it as a corporation. The partners may enjoy certain tax benefits individually while also avoiding the double taxes corporations must pay on revenue. According to CPA Stephen A. Nelson of LLC Formation Explained, LLPs enjoy the same tax benefits as limited liability companies, or LLCs, as well as most of the same legal protections.
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Structure
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A partnership files with the IRS as a partnership even if it has also registered as a limited liability entity at the state level. The limited liability model enables the company to have several owners or partners rather than just one. These owners or partners function as members of the company, contributing skills or work and sharing in profit distributions, along with a manager who also participates as a managing member. This structure allows the company to enjoy many of the advantages of a corporation without paying income taxes as a corporation would.
Savings
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A limited liability entity avoids the "double-dipping" that a corporation must suffer at tax time. With a typical corporation, the IRS taxes not only the corporation itself but also the distributions of profits paid to the business owners, effectively taxing the company twice on the same revenue. A limited liability partnership or company does not pay tax at the corporate level, paying only at the profit distribution level instead.
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Convenience
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When corporations report their taxes, the fact that they must file both on the corporate level and at the individual business-owner level adds an extra layer of time-consuming, labor-intensive paperwork to the filing process. A limited liability partnership simply files a form known as a 1065, then files a form known as K-1 for each owner's taxable profit from the business.
Other Benefits
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Owners of a limited liability company may enjoy other tax benefits as a result of the company's legal status. Owners who receive guaranteed payments rather than profit distributions, for instance, may participate in certain fringe benefits that favor them at tax time. Additionally, the company's managing members can deduct all of their health insurance premium payments on their individual tax returns, as long as the amount does not exceed the their share of net profits.
Considerations
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Even with the tax benefits that come with registration as an LLC, Gaebler Ventures notes that the limited liability model may not prove ideal or even possible for some kinds of businesses. Companies that rely on outside investors, for instance, may have better luck raising capital if they register as a corporation because the venture capital industry has reservations toward the structure used by many corporate entities. Even when the LLC form makes sense for a business, owners must remember that if they accept profit distributions rather than guaranteed payments, they will lose the ability to claim some of their fringe benefits when filing taxes.
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References
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