 Hello and welcome to this session. This is Professor Farhad and this session we're gonna be looking at an introduction to partnership taxation. Specifically, we're gonna start by looking at types of partnership. This topic is covered in the corporate income tax course, as well as the CPA exam regulation section as well as the enrolled agent exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where I house my 1,500 plus accounting, auditing, tax and finance lectures. This is a sample of all the courses that I cover, including the number of lectures. So not only I cover taxes, I cover other topics as well. On my website, I do have additional resources in addition to the lectures, which are on YouTube. I offer a multiple choice through false notes, PowerPoint slides, and if you're studying for your CPA exam, 2,000 plus CPA questions. So today I'm gonna be talking about a partnership. So generally speaking, we need to know what is a partnership? Basically, a partnership is an association, free association between at least two individuals, two persons or more, they don't have to be individuals per se, but two persons legally by law, which is a corporation could qualify as an individual to carry on a trade or a business with each contributing money, property, labor or skills. You have to contribute something and you expect to share in the profit and losses. So simply put, it's not only you share in the revenue, the most important is how you're gonna split the profit and the loss and you have to contribute something, either money, property, labor or skill to establish yourself and we're gonna be talking about those rules later on. Just FYI, partnerships are governed by sub chapter K of the internal revenue code and this is important because we're gonna be talking about schedule K and K1. So this is why we call it K because it's governed under that sub chapter as far as the IRS internal revenue code. The entity must be incorporated, it cannot be a corporation, it cannot be classified as a corporation, trust or a state, so it cannot be incorporated, okay? And you have to have a partnership agreement signed by each partner, you don't have to, but it's preferable that you do and what would the partnership agreement include? Basically, it's a contract between the partner. This document outlined the rights and the obligation of each partner and my advice to you is this, if you're gonna go into a partnership with any individual, even your brother, your own brother, it's better off being in writing, okay? The allocation of income, deduction and cash flow, the initial and future capital contribution, conditions for terminating the partnership and other matters. Simply put, how are you gonna form the corporation? How are you gonna allocate the income, allocate the deduction, allocate in the cash flow? Partnership has a lot of very specific rules, so if you don't understand the rules, it may backfire against you down the road, so that's why it's very important that you spell everything out in the written contract. Now type of partnership, we're gonna have basically two type of partnership, partnerships, but many type of partners, we're gonna have two type of partners, but many types of partnerships, but partnership entities are defined and formed under a state law. Just like corporation, they are state law, govern the partnership law, okay? There are typically distinguished based on the classification of partners, so we have two type of partners, okay? We have general partners and limited partners, and those are the partners that define what type of partnership we have, okay? So now we have to know who are the general partner or partners and who are the limited partners? Then we'll talk about the type of partnerships. So the general partners think of them as the risk takers. So let's assume you have an idea, an idea for some good business strategy or some idea for a business that's in need. Well, you don't have the money. Well, guess what? If you're gonna go to ask someone for money, most probably they don't really understand your business. So they're gonna ask you, well, what is my risk? And basically, you have to give them some protection because they're not invested in the idea, all what they can contribute is their money. So the general partners think of them as the people with the ideas. So they are the risk takers. Think of them that way, okay? And those are the people that actually run the company. General partners, they can participate in managing the entity, okay? But here's what happened with the general partners. The general partners are responsible for any debt incurred by the corporation. So if the entity incurred that, that is recourse to the partnership, okay, secured by the old partnership asset rather than specific partnership properties, a general partner can legally be called upon for repayment. So simply put, any obligation for the partnership becomes your own obligation. Now, why would you be a general partner? Most probably because you believe in your idea. Now, if you have the money, you want to be a limited partner or sometimes it's called a silent partner, okay? Limited partners, they cannot participate in the entity's management. They typically, they don't why? Because they are considered silent. So it's a general partner. You go to someone who has money and that individual, if you came to me with an idea and I don't understand your business, but I think it's a good idea. I would say, okay, I'll give you the money, but I want to be a limited partner because I'm not really sure how this business works. So I will take my chance, but I will take a limited chance. So that's why they called limited and silent mean they don't participate in the management. So simply put, they are only liable for the partnership that to the extent of any unpaid contribution, they have contractually agreed to make the partnership. So how much are they responsible for? It's what they agreed to be responsible for and in regards to the debt. So you cannot go after them once they satisfy this obligation, that's older obligation, okay? So we have to understand between the limited partners who are not risk taker, think of them as silent partner and the general partners who will dive into the risk, okay? Now, let's talk about the type of entities treated as a partnership. We have general partnership, we have limited partnership. This is, these are the type of partnerships, limited liability company and limited liability partnership. Now, if you know anything about my lectures, once I have a list, I'm gonna go over this list one by one, starting with the general partnership. A general partnership consists of two or more, obviously you have two, general partners who may participate in management. Simply put, general partnership, everyone is taking the risk. And here you have no limited partners. If you have a limited partners, then it becomes a limited partnership. If you have, let's just, if you have 200 general partner and one limited partner, it's no longer a general partnership because you have this one limited partner, okay? Now we understand where a limited partner is. So here we're talking about 200 general partners. They're all responsible for everything, okay? General partners often are used for operating activities and corporate joint venture. This is how, when we use general partnership. Limited partners, again, limited partnership from the word limited. A limited partnership is a partnership with at least one general partner and one or more limited partners. So simply put, in a limited partnership, you need to have a general partner because you need for someone to take care of the whole risk, right? But a general partner, a limited partnership does not exist without a limited partner. So you have to have, you have to have at least one of those and you could have many, many LPs, but you have to have at least one general partner because someone has to be responsible for the partnership, okay? So this is where a limited partnership is. These partnership often have numerous limited partners and they are used to raise capital for real estate development, oil and gas exploration, R&D and various financial investment vehicle. This is what they're used for. Now here's what's gonna happen. To reduce your exposure to the entity's liabilities, the general partners, they're often themselves have limited liability. So for example, what does that mean? It means they can be a C corporation. So simply put rather, so this general partner is a C corp and we already covered the C corp. C corp, they have their own protection or they can be an LLC, which is an LLC, we did not cover LLC. We're gonna cover LLC in the next slide. So you could also form a partnership entity in, as an LLC, okay? LLC, the owners are called members, not partners, okay? It's a hybrid type of partners. Now what does it mean hybrid? We're gonna see they're gonna have the benefit of a corporation with limited liability and the benefit of tax flow entity, which is really defined the term, they have the benefit of a corporation for liability and the benefit for taxation as a tax flow entity, okay? With respect to the LLCs that, members are treated as limited partners. So when it comes to that, they are protected. They are only responsible up to the amount that they contractually agreed to take on. LLC members generally participate in the management of the LLC. Now although you have limited liability to the debt, you can participate in management, okay? Well, what does that mean? It means the LLC combines the corporate benefit of limited liability for the owners with the benefit of the partnership taxation, including the single level tax. So simply put, your money, it's gonna be taxed once. It's gonna flow from the business to you personally. It's not gonna be taxed twice. If properly structured multi-owner, an LLC is generally treated as a partnership for all tax purposes. So as long as you structure it properly, you can treat it as a partnership, which is good. It means the money is taxed only once, tax flow entity. And we'll talk about this a little bit more in the next section, where we need to talk about how the income is taxed, okay? So the governing agreement of an LLC is known as the operating agreement. Just FYI term you need to be familiar with. Last but not least, LLP. LLP in most state, it's a limited liability company is treated very similar to general partnership. However, here's what's different about the LLP. LLP partner is not personally liable for any malpractice committed by other partners. So if we're talking about a doctor's practice, they have five doctors practicing. If one individual committed malpractice, guess what? The other four are not responsible. And this is what an LLP is. This is why doctors, lawyers, accountant form LLP. So this way, each partner is responsible for their own malpractice. So an LLP is currently the organizational form of choice for most large accounting firms. So when you go to work for the big four or an accounting firm, most likely, they are formed as an LLP. Now this is an overview about the type of partnership basically in the next session, we're gonna go and dive into a little bit more into the key concept and taxation of partnership. We're gonna talk a little bit more about the basis, how income is allocated inside basis, outside basis, when you contribute property, what are the tax consequences, so on and so forth. Now, as always, I would like to remind you, if you have any questions, email me. I strongly suggest you visit my website for additional lectures and additional resources as I have many, many lectures, not only taxes, but audit, finance, and especially accounting. Good luck and study hard, especially if you are studying for your CPA exam.