how does "pass through" income work in a partnership LLC?

5 Replies

Hey BP, These will likely be silly questions but I'm a noobie having a little trouble finding answers online. we plan on hiring a CPA, but I'd love to understand some of the basics. My brother and I are 50-50 owners in an LLC that buys and holds real estate (currently at 2 properties). We are both married and all 4 of us have regular w2 jobs. For 2018 taxes, I understand that the LLC will need to file it's own return. 1) if the LLC shows net earnings, would we just split that amount 50-50 as a distribution and add it to our personal taxable incomes? Do we have any option of leaving money in the LLC and not taking any distribution, and would that affect how we pay taxes? 2) If the LLC sustains a loss over the year, would we each be able to write off half that loss from our taxable income? if so, would we only be able to do that if we itemize? 3) we both would not have enough deductions in our personal lives to surpass the 24k standard deduction. The LLC still itemizes all its expenses and finds a net profit/loss anyway, and then that passes through to the owners, right? if we had plans to make charitable contributions to our church, would we do well to do that through the LLC so that we could write it off, and then still take the standard deduction? again, probably very silly questions, but if you can't ask the BP family, who can you ask?! would love any side tips anyone would care to give thanks for all the help. I could never have even gotten started without you all! Luke

Hi Lucas

So the Partnership will file it's own partnership tax return, form 1065. That return is basically a summary on all the income/expenses/ allocations to each partner Electra. 

THEN from that form a K-1 is generated for each partner. Think of this kind of like how your w-2 is a summary of all your earnings and income tax withholding for your job....the K-1 will be the summary of all your income and deductions from the partnership. 


Then that K-1 will be entered on each of your personal 1040 tax returns, and it's on your personal return that the tax is paid. 

1065 (Summary of the business)----> Creates K-1s ---> (Summary for each partner that gets inputted on the 1040, similarly to a w-2)---> 1040 - your personal tax return reports your portion of everything from the K-1 and pays taxes at your personal level. 

@Lucas Amuchastegui I cannot speak on the accounting/tax side of things but some items to keep in mind as you start your taxes with your CPA if you plan on buying more places with conforming or portfolio loans:

- If you take a distribution, it will show up ok your K-1 as such. This is the easier way to get credit for this income from an underwriting perspective but I’m sure it means more tax consequences.

- if you instead show net income from the K-1 in box one - you can be given credit for this income but only if your business returns pass a solvency test. Basically they are going to do a quick ratio (short term assets/short term liabilities) to make sure you have a 1:1 ratio or better. If this ratio is not as described, you will be given zero credit for your net income.

Hopefully this helps.

In addition to what @Natalie Kolodij said, the K-1 will report income or loss from the partnership regardless of any amounts that you take out of the partnership. Your accountant can explain the concept of basis to you. They can also explain whether the loss from the partnership can be claimed on your 1040 or not depending on other factors on your personal return. Take the time to find an accountant who will walk you through the basics of partnership account. Hope this helps!

@Lucas Amuchastegui

1) if the LLC shows net earnings, would we just split that amount 50-50 as a distribution and add it to our personal taxable incomes?

This will depend on the partnership agreement. While you are both 50/50 partners; do you agree to split income/expenses 50/50. If yes - then income will be split 50/50.

Do we have any option of leaving money in the LLC and not taking any distribution, and would that affect how we pay taxes?

The partnership has the option of making any amount of distribution it wants. Not making a distribution does not decrease the amount of taxable income that the partner will report. Some partnerships like to make a distribution to the partners in the amount of calculated tax the partner will have to pay. 
Example - Partnership allocates 100,000 of income. and the partner is in a 25% tax bracket. The partnership will distribute $25,000 to the partner to help him pay the tax.


2) If the LLC sustains a loss over the year, would we each be able to write off half that loss from our taxable income? if so, would we only be able to do that if we itemize? 

This can be a complex answer but ill keep it short. 
If the partnership's only activity is rental real estate - and the partnership sustains a loss. The character of the loss will transfer to the partnership.
Example - partnership has a $50,000 loss and it is split to each partner($25,000 each) on their individual K-1.
Now - the individual will have to see if they can take that $25,000 loss. If your income is above $100,000 - your rental loss may be suspended.
Whether you itemize or not does't come into play unless the partnership makes some contributions.

3) we both would not have enough deductions in our personal lives to surpass the 24k standard deduction. The LLC still itemizes all its expenses and finds a net profit/loss anyway, and then that passes through to the owners, right? if we had plans to make charitable contributions to our church, would we do well to do that through the LLC so that we could write it off, and then still take the standard deduction? again, probably very silly questions, but if you can't ask the BP family, who can you ask?! would love any side tips anyone would care to give thanks for all the help. I could never have even gotten started without you all! Luke

Making a contribution through the partnership or your personal name doesn't necessarily have a difference. 
If you make a $1000 contribution through the partnership - the partnership will report that each partner made a $500 contribution. The character of taxable items doesn't change whether you do something in the partnership's name or in your personal name.

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