“The foundation of every successful partnership is not just shared vision but shared values.” – Author unknown
A partnership is…
A partnership is not a taxpaying entity, but files an annual tax return, Form 1065, to report income, deductions, and other items. The same is true for a limited liability company (LLC) with two or more members; it also files a partnership return. Income, deductions, and other items pass through to partners and LLC members, who may be individuals, other partnerships, corporations, or other entities. Partners and LLC members report their allocable share of these items on their own tax returns. (Partnerships only become taxpayers if they’re audited under the centralized audit regime and adjustments are handled at the entity level.)
A look at statistics
Recently released tax statistics show that the number of partnerships, including limited liability companies that file tax returns as partnerships, are on the upswing. These statistics are for 2022, the most recent year for statistics.
- There were 4,500,186 million partnerships (0.7% more than in 2021). The number of partnerships has grown at an average annual rate of 2.95% over the period 2013-2022. Partnerships classified as limited liability companies (LLCs) accounted for most of this
- Partnerships with only 2 partners made up 58.4% of all partnerships, while those with 100 or more partners accounted for 0.4% of all partnerships (but 33.2% of all partners).
- The number of partners declined to 28.7 million, down from 30.6 million the year before (a 6% decrease).
- Partnerships passed through $2,558.0 billion in total income, which is a 34.3% decrease from 2021. They allocated over $3.8 trillion to their partners in 2021.
- Limited liability companies (LLCs) in the U.S. accounted for the majority (72.7%) of all partnership returns for 2022. This is the 21st consecutive year that LLCs dominated the number of partnership returns filed.
- Limited partnerships represented only 9.6% of all partnerships in 2022. Nonetheless, they reported 35.4% of the profits and almost half of total partners (49%).
- Total receipts (revenue) for filers in 2022 increased by 3.3% from the previous year to $12.5 trillion.
- Total assets for 2022 also increased 3.3%, from $ $50.8 trillion to $52.5 trillion.
- Over $2.5 trillion was allocated to partners in 2022.
Which industries dominated?
Real estate and rental and leasing accounted for approximately half (50.7%) of all partnerships and about one-third (33.9%) of all partners. But the finance and insurance sector reported the largest shares of total income (loss) minus total deductions or pass-through income (loss) (54.2%), total assets (58.8%), and total receipts (24.0%) for 2022.
Why do these statistics matter?
Even though C corporations are taxed at the highly favorable flat tax rate of 21%, many businesses continue to operate as pass-through entities, including partnerships and LLCs. There does not seem to be any shift away from this status, but going forward, you never know.
Audit prospects
Audits of certain partnerships are coming into focus:
- Last May, the IRS said it would increase audit rates by nearly ten-fold on large, complex partnerships with assets over $10 million, going from 0.1% in 2019 to 1% in tax year 2026.
- Last June, the IRS said teams were being formed to go after sophisticated tax-free transactions offered by abusive partnerships. These represent tens of billions of dollars, and audits are underway. The IRS issued guidance on the inappropriate use of partnership rules to inflate the basis of assets without triggering any change to the economics of their business. This is referred to as “basis shifting,” and it’s been identified as a transaction of interest (TOI). It’s going to get greater scrutiny from the IRS.
So, while the IRS seems to be focusing on more complex partnerships and certain partnership transactions, it’s unclear whether this will impact the audit rate for smaller partnerships.
Final thought
Partnerships, and especially LLCs, are viable options when choosing a form of entity for a business. Be sure to understand the legal, tax, financial, and personal ramifications before you enter into such a business arrangement.
To read more about IRS statistics, see this list of blogs here.
