2 member LLC confusion in Texas...

[Naz Hossain]

Hi BP - my partner and I have a LLC set up. Our attorney and CPA said that we will have to file for taxes as a partnership but I have been reading up that taxes are pass through? We are a 50-50 partnership with the operating agreement set up to where all profits, expense and losses are 50-50 as well. What happens when the expenses on my end are more than on my partners end? For example - I run the business from my home office ( utilities, home office space, etc) my partner is not local so all mileage to view properties locally are my expense. Would those get deducted 50-50 as well? Or am I completely off on a tangent. Any advice is appreciated!

[Michael Plaks]

@Naz Hossain

Your CPA did not explain to you what pass-through means? It is not an alternative to a partnership, it is a feature of the partnership.

Pass-through is a three-step process:

1. The partnership files a tax return reporting all shared income and shared expenses. For example: we made $100k from wholesale fees and spent $40k on marketing, technology, education etc. - resulting in a $60k net taxable income.
2. The partnership splits this result between the partners and sends each of them Form K-1 that basically says: you made $30k from this partnership (assuming 50/50 split).
3. Each partner adds his respective $30k to his personal income on his individual income tax return and pays taxes on his combined income from everything.

So, the calculations of profit/loss are done on the partnership level, but the resulting taxes are paid on the personal level. Hence the term pass-through.

Next, you suggested that your expenses could be higher than your partner's. Need to proceed carefully here. There're two types of expenses: business expenses of the partnership and business expenses of the individual partners. The difference is in whether the partnership as an entity agrees to pay for a particular expense from the business money that belongs to the partnership. 

Actually, we have 3 kinds, not 2 kinds of expenses. Personal expenses are divided into expenses that the partners are required to pay on their own, from their personal money, and expenses that the partners simply choose to pay on their own.

The 1st group, shared expenses, are deducted on the partnership tax return. The 2nd group, called unreimbursed partnership expenses, are deducted on the partners' individual tax returns. The 3rd group, let's call them elective expenses (there's no technical tax term for them), are not deductible at all.

As you can see, the distinction is important. It is regulated by your operating agreement. For example, it may require that the partners pay themselves for driving their personal vehicles for business purposes and for maintaining their home offices. The operating agreement must also say whether or not these expenses will be reimbursed by the partnership. So study your operating agreement and see if maybe it needs more work.

And I must say that, since you have a CPA and a lawyer on your team, it's their job to set all this up and explain it all to you. Otherwise, you should consider upgrading your advisors.