On November 2, 2015, President Obama signed H.R. 1314, the Bipartisan Budget Act (BBA) of 2015. Most of the news coverage of the new law dealt with its role in averting a default by the United States on its outstanding debts, and in warding off the threat of another federal government shutdown. New Jersey and New York business owners, however, should pay particular attention to the provisions of the BBA dealing with partnership taxation, since they could significantly change Internal Revenue Service (IRS) collection practices.
New Jersey law defines a “partnership” as “an association of two or more persons to carry on as co-owners a business for profit.” N.J. Rev. Stat. § 42:1A-2. When two or more people go into business together, they are typically deemed to have created a “general partnership,” in which each partner is jointly and severally liable for the partnership’s debts and obligations. N.J. Rev. Stat. § 42:1A-18. They may also set up their business using a variety of business forms allowed by New Jersey law, such as a limited partnership or a limited liability partnership. For the purposes of federal income tax, most partnerships receive similar treatment from the IRS.
Federal law defines “partnership” broadly to include various business ventures that are not, based on the definitions established elsewhere in the Tax Code, a corporation, trust, or estate. 26 U.S.C. § 761(a). Corporations must pay federal income tax directly to the IRS, and shareholders must pay tax on dividends received from the corporation. This is often known as “double taxation,” since it imposes income tax twice on the same money. Partnerships, along with corporations that elect to be taxed under Subchapter S of Chapter 1 of the Tax Code, generally avoid this tax treatment. The Tax Code expressly states that partnerships are not liable for income tax themselves, but instead the partners pay taxes for the partnership “in their separate or individual capacities.” 26 U.S.C. § 701.