Publication 541: Partnerships

Publication 541, a valuable resource offered by the Internal Revenue Service (IRS), serves as the definitive guide for understanding the intricate world of partnership taxation. This publication caters specifically to both partnerships and individual partners, equipping them with the necessary knowledge to navigate the tax landscape effectively.

What is a Partnership?

A partnership is an unincorporated organization with two or more members who carry on a trade, business, financial operation, or venture and divide its profits. Co-ownership of property for rental or lease purposes generally doesn't constitute a partnership unless the co-owners provide services to tenants.

Types of Organizations Classified as Partnerships

  • Organizations formed after 1996 are partnerships unless they are specifically excluded, such as corporations or LLCs electing corporate classification.
  • Organizations formed before 1997 are generally grandfathered in as partnerships unless they elect corporate status.
  • Community property businesses owned by spouses can be classified as partnerships for tax purposes.

Special Rules for Partnership Interests

  • Gifts of capital interests within a family may have limitations on the donee's (recipient's) distributive share of income.
  • Section 1061 recharacterizes certain capital gains from applicable partnership interests held in connection with substantial serviceleistungen (services) as short-term capital gains.

Spouses in Business

  • Spouses running a business together and sharing profits and losses may be considered partners.
  • They can file a joint return and report business income/loss on Form 1065.
  • Alternatively, they can elect to treat the venture as a sole proprietorship if they meet specific requirements.

Partnership Agreements

  • Agreements can be written or oral and can be modified after the tax year but before the filing deadline (excluding extensions).
  • If the agreement is silent on a matter, local law provisions apply.

Terminating a Partnership

  • A partnership terminates when all operations cease and no part of the business continues by any partners.
  • The partnership's tax year ends on the termination date.
  • A short-period return (covering the period from the beginning of the tax year to the termination date) may be required.

Electronic Filing

  • Certain partnerships with over 100 partners and religious/apostolic organizations exempt under section 501(d) are required to file electronically.
  • Other partnerships generally have the option for electronic filing.

Exclusion from Partnership Rules

  • Certain partnerships not actively conducting a business can elect exclusion if all partners agree and can calculate their taxable income independently.
  • Investing and operating agreement partnerships can qualify for exclusion under specific conditions.

Partnership Return (Form 1065)

  • Every partnership engaged in a trade or business or having gross income must file Form 1065.
  • The return details partnership income, deductions, and partner information, including their distributive shares.

Partnership Distributions

  • Distributions include withdrawals, distributions of earnings, and partnership liquidation.
  • They don't affect a partner's distributive share but may impact their basis in the partnership interest.
  • Distributions generally don't result in gain or loss for the partnership.
  • Exceptions include distributions of unrealized receivables or substantially appreciated inventory items.

Partner's Gain or Loss

  • Partners generally recognize gain on distributions only if the money received exceeds their basis in the partnership interest.
  • This gain is typically treated as capital gain.
  • Distributions of property (other than money) generally don't trigger gain recognition until the property is sold.