Question

• Why would a taxpayer think of forming a partnership type of business, as compared to a corporation?
• Why a partnership should communicate with its partners before making an election to expense property acquisition costs under § 179?

Answer 1

1. Businesses as partnerships do not have to pay income tax; each partner files the profits or losses of the business on his or her own personal income tax return. This way the business does not get taxed separately. Easy to establish.

Advantages of partnerships

Unlike an S corporation shareholder, anyone or any entity can be a partner. S corporations are limited to 100 shareholders; only certain individuals, estates, and trusts are eligible to be shareholders. C corporations and nonresident aliens cannot be shareholders of an S corporation.

S corporations are limited to a single class of stock; income and losses must be allocated on the same basis to each shareholder. Having only one class of stock may affect the corporation's ability to raise capital. A partnership can have different classes of partners and has more flexibility for allocating income and losses to different types of partners.

Partnership liabilities can increase a partner's basis in the partnership, offsetting distributions of cash, and reducing their taxation. The increased basis allowed partners to use losses generated by the partnership. Liabilities of an S corporation do not create a stock basis; separate bases in stock and debt must be calculated. This lack of basis may limit the use of losses generated by the S corporation.

Contributions of appreciated property by a partner to the partnership generally are not taxable, even if the partner is not part of a group controlling the partnership. Contributions by a shareholder to a corporation are tax-free only if the shareholders are part of a group controlling 80 percent of the corporation after the contribution. However, a partnership must follow special allocation rules for handling built-in gain on the contributed property, whereas S corporations do not have special allocation rules in this circumstance.

In general, a partnership offers more flexibility than an S corporation in the treatment of taxes. However, S corporation shareholders do have limited legal liability, while general partners are not insulated from the partnership's debts and liabilities.

2. A partnership may elect to expense property under IRC §179 only if the partnership uses the property predominantly (more than 50%) in the active conduct of a trade or business. The determination of whether the partnership is actively conducting business is made by taking into account the activities of all partners.

Deduction Limited to Taxable Income

The IRC §179 deduction that a partnership may pass-through is limited to the partnership’s taxable income from the active conduct of its trade or business. The portion of a section 179 deduction disallowed by reason of the taxable income limitation is carried forward by the partnership until it has sufficient taxable income from the active conduct of its business to absorb the suspended deduction.

The taxable income limitation is also applied separately at the partner level.

A partner may only take taxable income from a partnership into account in applying the active taxable income limit if the partner is actively engaged in the partnership’s trade or business. Taxable income from other trades or businesses actively conducted by the partner, including wages from employment, count toward the partner’s active taxable income.