US Partnership Taxes: A Complete Guide for Small Business Owners

Understanding how US partnerships are taxed is essential for business owners managing their tax responsibilities. Unlike corporations, partnerships do not pay income tax at the business level. Instead, all profits, losses, deductions, and credits pass through to the partners, who report them on their individual tax returns.

For US small businesses, knowing the key tax responsibilities of partnerships can help avoid penalties and optimize tax planning. With expert corporate tax services, businesses can navigate complex tax laws, maximize deductions, and ensure compliance. This guide covers everything from tax filings and self-employment taxes to deductions and state tax obligations.

How US Partnerships Are Taxed

Pass-Through Taxation: No Corporate Tax

Partnerships operate under a pass-through taxation model, meaning the business itself does not pay federal income tax. Instead, the partnership must file:

• Form 1065 (U.S. Return of Partnership Income): Reports the business’s income, deductions, and other tax details to the IRS.
• Schedule K-1 (Partner’s Share of Income, Deductions, Credits, etc.): Details each partner’s share of profits or losses, which must be reported on their personal tax returns.

Since partnerships do not pay income tax at the business level, partners are taxed individually based on their share of the earnings.

Self-Employment Tax for Partners

Partners in a general partnership are classified as self-employed and must pay self-employment taxes, which cover Social Security and Medicare contributions.

• General partners must pay self-employment tax on their share of business profits, whether or not they withdraw the funds.
• Limited partners usually do not pay self-employment tax unless they actively participate in running the business.

As of 2025, the self-employment tax rate remains at 15.3%, with Social Security tax applied to the first $176,100 of net earnings. To avoid unexpected tax liabilities, US small businesses structured as partnerships should plan for self-employment tax payments throughout the year.

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Guaranteed Payments to Partners

Partnerships may compensate partners through guaranteed payments, which function similarly to a salary but are taxed differently.

• For the partner: These payments are taxed as ordinary income and subject to self-employment tax.
• For the partnership: They can be deducted as a business expense, reducing taxable income.

Guaranteed payments ensure that active partners receive compensation regardless of the partnership’s overall profits.

Tax Elections and Deductions

Partnerships can make strategic tax elections to optimize tax treatment:

• Cash vs. Accrual Accounting: Partnerships can choose to report income using either the cash method (taxed when received) or the accrual method (taxed when earned).
• Section 754 Election: Adjusts the tax basis of partnership assets when ownership changes, helping to reduce future capital gains taxes.

Common deductions available to partnerships include:

• Business expenses such as rent, utilities, and office supplies
• Startup costs and legal fees
• Depreciation on business assets

Taking full advantage of tax deductions can help US small businesses reduce their taxable income and improve financial stability.

State and Local Tax Obligations

While federal taxation follows pass-through rules, state and local tax laws for partnerships vary. Some states impose additional taxes, such as:

• Franchise taxes or business registration fees
• State-level partnership tax returns
• Local business taxes at the city or county level

It’s important for partnerships to research state-specific tax rules and consult with an accountant to ensure full compliance.

Summary

For US small businesses, understanding how US partnerships are taxed is essential for effective tax planning and compliance. Because partnerships operate as pass-through entities, they do not pay federal income tax at the business level. Instead, profits and losses are reported on each partner’s individual tax return. General partners must pay self-employment taxes on their income share, while limited partners have different tax obligations. Partnerships are also responsible for filing Form 1065 and providing Schedule K-1s to their partners.

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