One of the advantages of operating a business as a partnership is the right to make special allocations of tax items among the partners. You have the same opportunity if you run your business as an LLC that’s treated as a partnership for federal tax purposes.
In this article, the term partnership will cover an LLC that’s treated as a partnership for tax purposes, and the term partner will cover an LLC member who is treated as a partner for tax purposes. Onward.
What Is a Special Tax Allocation?
A special tax allocation is an allocation of an item of partnership loss, deduction, income, or gain among the partners that’s disproportionate to the partners’ overall ownership interests.
The best measure of a partner’s overall ownership interest is the partner’s stated interest in partnership distributions and capital, as stated in the partnership agreement.
Example. An allocation of 80 percent of a partnership’s 2020 tax loss to Partner A, whose stated ownership is only 25 percent, is a special allocation of the tax loss.
After the partnership allocates its tax items among the partners, the allocated amounts (including any special allocations) are passed through to the partners on their annual Schedules K-1 received from the partnership.
Each partner then takes the passed-through amounts reported on Schedule K-1 into account on the partner’s federal income tax return (Form 1040 for an individual partner).
The partnership itself does not pay federal income tax. You and the other partners pay tax at the owner level. This is called pass-through taxation, because the tax consequences of the partnership’s activities are passed through to ... Log in to view full article.