Partnership Taxation
Definition
Partnership taxation is the default IRS tax classification for any business entity with two or more owners (such as a multi-member LLC or a general partnership). Under partnership taxation, the business entity itself does not pay federal income tax. Instead, the profits and losses "pass through" directly to the partners (owners), who pay tax on their share at their individual income tax rates.
Why it matters
Partnership taxation is highly desirable because it avoids the "double taxation" that C-Corporations face. However, it requires specific IRS paperwork. The partnership must file an informational return (Form 1065) every year to report the total business income and expenses. The partnership then generates a Schedule K-1 for each owner, showing exactly what percentage of the profit or loss belongs to them.
Example
Tom and Greg co-own a multi-member LLC that generates $80,000 in net profit. Under partnership taxation, the LLC pays $0 in corporate tax. It files Form 1065, and issues a Schedule K-1 to Tom for $40,000 and a Schedule K-1 to Greg for $40,000. Tom and Greg each report that $40,000 on their personal 1040 tax returns.