This blog is primarily focused on sole proprietors. However, there are occasions when writers, authors, illustrators and literary agents will want to form a partnership for a one-time event or for a specific set of activities when additional talent (and investment) are needed to provide a synergistic result. For that reason, I will post some key information regarding partnership accounting and taxation.
First, and foremost, you need a written partnership agreement that covers the role and responsibility of each partner. There are numerous issues to cover regarding the management of the partnership as well as the profit/loss allocation formula to each partner that should be covered in the partnership agreement. You will want to engage an attorney to prepare this document for your specific circumstances and avoid “instant online partnership agreements” where one-size does not fit all. You should also have your personal attorney review the document before you sign it. He or she can explain any part of the agreement you do not fully understand before you sign it.
Reporting Partnership Profit and Loss
A partnership files Form 1065. Form 1065 reports the overall partnership profit or loss and also each partner’s share of that profit/loss using attached Schedule K-1 forms (copies of the Schedule K-1 are also sent to each partner to report their share on their personal return). The partnership pays no tax on partnership income at the partnership level; each partner reports his or her share of partnership profit or loss and special deductions and credits and any distributions received from the partnership (if any), as shown on Schedule K-1.
Each partner will report his or her share of the partnership profit or loss for the partnership year that ends in their tax reporting year. If the partner and the partnership are on a calendar-year basis, the partner reports his or her share of the 2012 partnership profit or loss on their 2012 personal income tax return. If the partnership is on a fiscal year ending June 30, for example, and the partner reports on a calendar year, the partner reports on his or her 2012 return their share of the partnership profit or loss for the whole fiscal year ended June 30, 2012–that is, partnership profit or loss for the fiscal year July 1, 2011 through June 30, 2012.
Health Insurance Premiums
A partnership that pays premiums for health insurance for partners has a choice. It may treat the premium as a reduction in distributions to the partners. Alternatively, it may deduct the premium as an expense and charge each partner’s share as a guaranteed salary payment taxable to the partner. The partner reports the guaranteed payment shown on Schedule K-1 as nonpassive income on Schedule E and may deduct 100% of the premium on Line 29, Form 1040, as an above-the-line deduction from gross income.
A guaranteed salary that is fixed without regard to partnership income is taxable as ordinary wages and not as partnership earnings.
As a general partner, you pay self-employment tax on your net partnership income, including guaranteed salary and other guaranteed payments. Limited partners do not pay self-employment tax, unless guaranteed payments are received.