How To Get Ahead Of The Game With Partnership Taxes
Working with a partner or partners can be very appealing. When starting a cleaning business partnership, many people think about shared goals, what the partners can achieve together or the amount of money they can make.
What most people who set up partnerships don’t think about are taxes.
As in other parts of life, taxes are an important part of a cleaning business partnership.
When you’re a solo cleaner, it’s easy to fall into bad habits and be clueless about taxes.
If you get into trouble with local, state and federal tax departments as a solo cleaner is mostly your (and your household’s) own hard time to grind through.
Related: Cleaning Business Tax Basics
However, when you’re in a partnership, a lack of care with taxes can impact a lot more people.
Partnership tax troubles can put stress on your household and your partner’s household. Partnership tax trouble can cause a lot of people to grind through a hard time.
To avoid tax trouble, you and your partner need to to get ahead of the game by being clear about all of the taxes you’re expected to pay as partners, which taxes you still have to pay on your own and how to stay on top of them.
How Taxes Are Paid in Partnerships
Business partnerships including general partners, limited partners and LLCs that choose to be taxed as partnerships are considered pass through entities.
As a pass through entity, the partnership or its income is not directly taxed by federal, state and local governments.
Instead, business income is “passed through” through the partnership to the individual owners/partners.
Business income from a partnership is taxed on the individual partners federal and state income tax forms.
The Annual Partnership Tax Dance
The tax paying process for partnerships usually includes the partnership calculating and filing taxable income on a Federal Form 1065 each year.
The partnership then files an IRS Form Schedule K-1 for every single partner which divides the partnership income according to ownership percentage.
Some partners may be due more income than other partners according to their partnership agreement or Operating Agreement if they are in an LLC.
Partners then report their share of income on their personal federal tax return form (Form 1040).
Partners pay individual income tax based on their personal taxable income share from the partnership.
Partners Must Pay Self-Employment Tax
General partners, limited partners and partners in an LLC are not employees of the partnership.
They are owners and expected to pay federal estimated self-employment tax or SE tax once per quarter (every three months) to the federal government.
In the eyes of the federal government, general partners are sole proprietors multiplied by two or more.
Related: What Is Self-Employment Tax? And Why You Should Care
Most state governments also have their own version of self-employment (SE) tax.
Like federal SE tax, state SE tax is often paid quarterly (every three months).
States With No SE Tax or Income Tax:
✏️ Note: Be aware that states with no self-employment tax may still have state-wide business taxes (plus sales and use taxes) you have to pay monthly, quarterly or yearly.
For example, Washington State has the Business and Occupation (B&O) tax that must be filed by all businesses similar to self-employment tax in other states.
Limited Partnerships Have Different SE Tax Rules
On the other hand, if you and a group of people have set-up a limited partnership, the rules are a bit different.
In a limited partnership, all working partners who get guaranteed payments for services performed are expected to pay Self-employment (SE) tax.
However, non-working partners who are simply investors in the business don’t pay SE tax on their share of income.
How This Can Work In Real Life
Three cousins in the Morris family decide to start a house cleaning company together.
They form an LLC (Limited Liability Company) to protect personal assets like their bank accounts, homes and cars from business debts.
The cousins decide to run the their cleaning business as a limited partnership in their LLC Operating Agreement and in their Partnership Agreement.
All three Morris cousins work day-to-day as general partners in the business.
Each cousin pays quarterly SE tax payments on what they earn from the business.
A fourth cousin also invests in the business and agrees to become a general partner in the LLC Operating Agreement.
She does bookkeeping for the company in exchange for guaranteed monthly payments.
As a general partner, their bookkeeper cousin pays SE tax on the guaranteed monthly amount she earns from the business.
The Morris cousins also talk their grandmother and an aunt into investing in their cleaning business as limited partners.
Neither their grandmother nor their aunt works in the business.
In the LLC Operating Agreement, the grandmother and aunt sign on as limited partners.
They are simply investors and cheerleaders for the business.
They pay income tax on payments they receive each year from the business, but no SE tax.
Investing and cheerleading is SE tax free for the grandmother and aunt.
When Your Business Partner Is Your Spouse
According to US federal tax law, married couples can set-up and run their business several ways.
Married couples can work together as employer and employee, general partners and as partners in an LLC or corporation.
In most cases, the IRS considers married couples in unincorporated businesses general partners.
As general partners, the couple must report business income on Form 1065, U.S. Return of Partnership Income.
However, a married couple can choose to work and file taxes as joint-sole proprietors in a Qualified Joint Venture or QJV.
Qualified Joint Venture Rules
The IRS requires married couples who choose to run a business in a QJV to follow 5 rules:
If these rules are followed, each spouse is required to file their own yearly taxes as joint sole proprietors with Schedule C reports of their share (usually 50-50) of the business’ income, gains, losses, deductions and credits. Each spouse also needs to file separate SE tax forms every quarter. IRS source
How A Qualified Joint Venture Helps
With a QJV and separate tax filing, each spouse pays into the Social Security programs under their own names.
Retirement benefits, disability benefits, survivor benefits, and Medicare benefits are based on what each person pays into the program.
According to the IRS, in most cases, choosing a QJV will not increase the total
tax a couple owes on the joint return. IRS source
The Community Property State Choice
Most states consider married couples automatic business partners. However, married couples in community property states can choose to run their business as a sole proprietorship if they are not in a QJV.
The 9 community property states are:
Running a sole proprietorship in a community property state can cut down on the paperwork a married couple deals with at tax time.
The downside is taxes are filed under only one spouse’s name, even though both spouses worked in the business and shared in its profits and losses.
As a result, only one spouse receives credit for Medicare and Social Security contributions and the other does not.
That credit for contributions is important at retirement, in case of disability, divorce or death of the covered spouse.
2 Important Federal Tax Partnership Forms
Federal Partnership Tax Form 1065
All US based business partnerships must file Form 1065 – U.S. Return of Partnership Income.
Unincorporated businesses (general partnerships) jointly owned and operated by married couples not in a QJV are considered partnerships by the federal government and are required to file Form 1065.
Form 1065 gives the IRS a yearly financial snapshot of the partnership’s profits, losses, deductions and credits including:
In order to file Form 1065, your partnership must have year-end financial statements like a profit and loss statement (P & L) and a balance sheet.
Your partnership must also have an Employer Identification Number (EIN), NAICS code and partnership start date.
Form 1065 is best prepared by an accountant or qualified tax preparer for the partnership. Form 1065 is due each year on March 15. No tax payment is sent in with the form.
Schedule K-1
All partnerships that file a federal partnership return (Form 1065), must also file an IRS Form Schedule K-1
This IRS form shows the share of income and losses for each partner by percent of ownership over the past year.
The share percent is tied to how much each partner put into the business or how much a share of the business they agreed on in their partnership agreement.
The Schedule K-1 form is best prepared by an accountant or qualified tax preparer for the partnership. Schedule K-1 forms should be issued to each partner no later than March 15 each year.
All partners whether working or non-working, should get a Schedule K-1 and file it with their federal taxes.
State Partnership Tax Returns
Any general, limited or LLC partnership that files Federal Partnership Tax Form 1065 must also file a state partnership tax return in most states.
In some states, partnership returns are information returns only. With information returns, no payment is required. In other states, payment is expected with the tax return.
Get more information from a Certified Public Accountant (CPA) or qualified tax preparer to find out if your partnership must file state returns and whether any payment is expected.
Special State Taxes For Partnerships
In addition to state partnership returns, some states have special requirements for general, limited and LLC partnerships. They include:
Delaware: General partnerships are required to pay an annual Franchise Tax of $300 to the state.
Georgia: General Partnerships are required to file an annual state tax return known as the Georgia Income Tax Return Form 700.
Illinois: Partnerships are required to pay the state’s Personal Property Replacement Tax at a rate of 1.5% of net income.
Kansas: Each general partner is must pay state income taxes based on their percentage of ownership.
Maryland: Partnerships are required to pay tax on income earned by partners (non-resident members) who live out of state.
Oregon: Partnerships pay an annual Partnership Minimum Tax of $150.00.
Vermont: Partnerships pay a Business Entity Tax of $250.00 or a percentage of annual income.
Keep Your Tax House In Order
Keeping track of partnership income, expenses, shares and percentages is something you and your partners will have to stay on top of every week, month, quarter and year.
Careless record keeping can lead to tax trouble and a tough time for you, your partners and your combined households.
Related: Why You Should Create A Money System For Your Cleaning Business
The long list of tax forms your partnership will need is best handled by a professional like an accountant or qualified tax preparer.
It’s a good idea to get that person on board before you start your cleaning business partnership.
If you partner with the right person, a partnership can be a great way to build a thriving cleaning business.
However, a business partnership brings with it more paperwork, responsibilities and things you need to be aware of like taxes.
If you and your partner(s) keep your tax house in order, you can get ahead of the game and build the business of your dreams.
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