Business Entity Taxation: Partnerships, S-Corps & LLCs

Entity selection represents one of the most consequential decisions for new businesses, affecting tax liability, administrative burden, liability protection, and future flexibility. This unit examines the tax implications of entity choice and provides a framework for advising clients on entity selection.

Partnership formation generally occurs tax-free under Section 721, but calculating initial basis correctly and understanding the treatment of contributed property, liabilities, and services establishes the foundation for all future partnership tax calculations.

Partnership flexibility in allocating income, gains, losses, and deductions among partners is constrained by the substantial economic effect requirements of Section 704(b). Understanding these rules enables practitioners to structure valid special allocations while avoiding recharacterization of partnership agreement provisions.

S corporation status provides pass-through taxation while allowing employment tax savings on distributions beyond reasonable compensation. Understanding eligibility requirements, reasonable compensation standards, and the built-in gains tax enables proper S election planning and compliance.

Schedule K-1 reports each partner's or shareholder's distributive share of income, deductions, and credits from pass-through entities. Accurate K-1 preparation and basis tracking enable partners and shareholders to properly report passthrough items and claim allowable losses on their individual returns.

The Section 199A qualified business income deduction, enacted by the Tax Cuts and Jobs Act, allows pass-through business owners to deduct up to 20% of qualified business income. Understanding the complex limitations and planning opportunities enables tax professionals to maximize this valuable deduction for clients.

Self-employment tax at 15.3% represents a significant burden for sole proprietors and active partners. Understanding calculation rules, exceptions, and planning strategies enables tax professionals to minimize self-employment tax while ensuring compliance with IRS requirements and avoiding unreasonable position penalties.

Partnership and S corporation distributions and liquidations involve complex basis calculations, potential gain or loss recognition, and special rules for disproportionate distributions of hot assets. Understanding these rules enables proper planning of exit strategies and distribution timing to optimize tax results.