Can an LLC Be a Partner in a K-1 Partnership?

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Can you form a limited liability company and have it operate as a partner in a K-1 partnership? The answer is yes, and there are good reasons to do so. In particular, the use of an LLC as a partnership member can protect partners from the liability risks that individual partners face.

Overview of the General Partnership

A general partnership is a business type, not a legal structure. A partnership is a relationship, informal or formal, that develops when two or more people do business together, and each contributes something of value to the business. When you and your fellow owners operate your business as a partnership and are invested and involved in the partnership as an individual, none of you is distinct from the others or the general partnership. You have joint and several liability, meaning each partner is liable for any debts and liabilities the partnership or the other partners incur.

Overview of LLCs

LLCs are different. Recognized as legally separate entities in all 50 states, LLCs can enter into contracts, conduct business, hold assets and incur debts. However, as an owner – called a member – you are not responsible for any liabilities or debts arising from the LLC, unless you personally guarantee a contract or debt. In this way, your personal assets are shielded from the LLC's business activities, with your loss limited to the contributions you made to the LLC.

Can an LLC be a Partner?

So can an LLC be a partner? Yes. General partnerships have no restrictions on who can be owners. Owners can range from individuals to corporations to LLCs. In addition, states do not place restrictions on the types of businesses in which LLCs can participate. Therefore, LLCs can serve as general partners in a partnership.

Due to the liability you are exposed to as a partner, you (and/or your co-owners) may opt to organize and operate your business as an LLC and participate in the general partnership as an LLC. By doing this, your LLC is open to full liability as a general partner, but the LLC shields you as a member from personal liabilities.

Taxes for an LLC as a Partner

Taxes for an LLC as a partner can be a little complicated.

As a business entity that is not legally distinct from its owner, your partnership is taxed solely at the owner level. However, the partnership must file a tax return, Form 1065, which provides a record of the partnership's earnings. Schedule K of this return separates the total earnings into income, deductions and credits.

Next, using Schedule K as the basis, someone must prepare a Schedule K-1 partnership form, which allocates these items to each partner based on his or her ownership percentages.

Handling the Tax Forms

The partnership mails a copy of the Schedule K-1 to each partner, including your LLC. Each partner then incorporates the information from his or her Schedule K-1 in his or her applicable tax return to pay the proportionate share of the partnership's taxes.

As an LLC, the tax return in which you will then include this income depends on your LLC's tax status. If your LLC files as a corporation, include the K-1 information on Form 1120. If your LLC files as a partnership, include the K-1 information on Form 1065. If your LLC files as a sole proprietor, include the K-1 information on your personal tax return, Form 1040.

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