Pass-through entities and NQDC plans

• Author: Marla J. Aspinwall - Michael G. Goldstein
• Pages: 277-288

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CHAPTER X

PASS-THROUGH ENTITIES AND NQDC PLANS

I.

INTRODUCTION — DEVELOPMENT OF PASS-THROUGH ENTITIES

Pass-through entities have become more popular, particularly since the Tax Reform Act

of 1986 and the enactment of statutes allowing for the creation of limited liability companies

(“LLC”) and limited liability partnerships (“LLP”). For purposes of this Chapter, the phrase

“pass-through entities” simply refers to entities which generally are not subject to federal income

tax at the entity level, but the entity’s taxable income “passes through” to the owners and is taxed

as additional income to the owners. The pass-through entities discussed in this Chapter are the

general partnership, the limited partnership, the limited liability partnership, the S corporation

(also called the “Subchapter S corporation”), and the limited liability company.

A.

Before the Tax Reform Act of 1986. The partnership is one of the oldest forms of

doing business. Generally, if two or more individuals or entities join together for a common

business purpose and share profits and losses, a partnership exists.1 In 1914, the Uniform

Partnership Act was approved by the National Conference of Commissioners on Uniform State

Laws.2 The general partners of a partnership are personally liable for the obligations of the

partnership entity.3 In contrast, the shareholders of a C corporation generally are not personally

liable for the obligations of the corporation.4

Eventually states began to enact statutes allowing for the formation of limited

partnerships.5 A limited partnership has one or more general partners and one or more limited

partners. The general partners are personally liable for the obligations of the partnership, but the

limited partners are not (except to the extent of their investment in the partnership).6

Partnerships and corporations are taxed differently. There is only one level of tax imposed

on partnership net income.7 While a partnership files an income tax return,8 normally it pays no

tax, and the net income of the partnership is deemed to “pass-through” to the partners and is

taxed on the partners’ income tax returns.9 In contrast, corporate net income can be subject to

two levels of income tax. First, the net income of the corporation will be taxed at the corporate

1 See J. Crane and A. Bromberg, Law of Partnership, 34 (1968); Uniform Partnership Act, § 6(1).

2 R. Steffen, Agency-Partnership, 696 (1969).

3 J. Crane and A. Bromberg, supra note 1, at 3.

4 Id.

5 “By 1973, the [Uniform Limited Partnership Act] had been enacted by every state [except Louisiana]. . . .”

Smith & Bookout, Limited Partnerships: Legal Aspects of Organization, Operation and Dissolution,

24-3rd C.P.S. (BNA), at A-1.

6 Id. at 3.

7 IRC § 701 (“A partnership as such shall not be subject to the income tax imposed by this chapter”).

8 IRS Form 1065.

9 IRC § 701.