How are partnerships taxed?

• A. The partnership pays tax on profits; partners are not taxed.
• B. Partnerships are tax transparent; partners pay tax on income; the partnership entity is not taxed.
• C. Partners pay tax only on distributions.
• D. The partnership is taxed as a separate entity at corporation rates.

Answer: (B)

The key idea is pass-through taxation. In a partnership, the entity itself isn’t taxed on its profits. Instead, the profits (and losses) pass through to the individual partners in proportion to their share, and each partner pays income tax on their allocated amount. The partnership doesn’t pay tax as a separate entity.

This is why the statement that partners pay tax on their income and the partnership entity is not taxed is the best description. Tax is based on each partner’s share of the profits, not on distributions alone, and not at corporate rates for the partnership itself.

Why the other ideas don’t fit: saying the partnership pays tax on profits would imply the entity is taxed, which isn’t the general rule. Suggesting tax is due only on distributions ignores that partners are taxed on their share of profits whether or not those profits are distributed. Finally, treating the partnership as a separate entity taxed at corporation rates doesn’t match the typical pass-through treatment, where the entity itself isn’t taxed and partners bear the tax.