Question

"Legal Entities" Our reading this week covers the different types of legal entities. Please chose a legal entity type and discuss the entity’s tax and non-tax characteristics. Then, describe a situation in which a taxpayer would choose this type of entity by providing an example.

Answer 1

The legal entity type that I have selected is ‘partnership’. A partnership entity is a pass through tax entity and the income of a partnership is divided among the partners and this is reported by each individual partner on his/her Schedule E and the net results in Form 1040. Partnership entities don’t pay taxes. While a partnership does not pay taxes it still has to file with the IRS. The form which has to be filed is Form 1065. This form will report the partnership’s income, expenses and profits. The main non tax characteristics of a partnership is that it should have at least two persons and that it is governed by the policy of mutual agency i.e. acts of partners bind each other as well as the firm.

A situation in which a tax payer would choose this type of entity is when the tax payer wants to split income rights among the partners and all income, gains and losses be allocated to partners on the basis of their share in the partnership. In case of a corporation tax has to be paid at the corporate level before the earnings are distributed to the shareholders who pay tax at the individual level. Thus a situation in which the individuals want to avoid being taxed both at the corporate level and the individual level they will prefer a partnership as a partnership serves a pass through entity.