Does a Partnership Retain Profits?
Every successful business earns a profit, at least over the long term. But definitions of profit depend on the ownership structure of your business. Closely held businesses such as partnerships and sole proprietorships are required to define profit as net earnings, regardless of whether the owners draw money out of the business. A partnership has the option to retain profits by leaving them in the business account for future purchases. Regardless of how the profits are distributed, the Internal Revenue Service treats them as taxable income.
Profit is the amount left over after subtracting operating income from gross revenue. Operating expenses include payroll, materials, rent, auto expense and utilities. Unlike corporate structures such as C corporations, in which the salaries of owner operators are included in operating expenses and lessen the company's net taxable profit, owners of a partnership business are taxed on their share of the company's net earnings regardless of how much they pay themselves out of the company account.
For a partnership, retaining profits is a matter of keeping earnings in a business account rather than withdrawing them for personal use. A partnership may opt to retain profits in order to improve cash flow, plan for future capital investments or have collateral on hand when applying for a loan. The decision of whether a partnership retains profits has no tax consequences because the owners of partnerships are taxed at individual income tax rates regardless of whether they retain or withdraw their earnings.
A partnership business has the option of distributing profits to its owner operators. Profit distribution involves taking money out of business accounts for personal use, and it can occur on a regularly scheduled basis, whenever there is enough money to spare or at the end of the year when you see how much cash you have left. Profit distribution often depends on cash flow or whether the company has enough available cash to cover its operating expenses.
Business partners are liable for paying income taxes on all of the profit their business earns, whether that money has been retained in business accounts or distributed to the partners. Profit from a business partnership is taxed as individual personal income. Partners report this profit as taxable income relative to the percentage of the business that they own. For example, a partner who owns 60 percent of a business that earns $10,000 in profit is taxed on $6,000 of that profit.