Partnership

A partnership is the relationship between two or more persons who join to carry on a trade or business, including farming. Each person contributes money, property, labor, or skill, and expects to share in the profits and losses.

For federal income tax purposes, the term "partnership" includes a syndicate, group, pool, joint venture, or similar organization carrying on a trade or business and not classified as a trust, estate, or corporation.

Family partnership. Members of a family can be partners. For instance, a husband and wife or parents and children can conduct a farming enterprise through a partnership. To be recognized as a partnership for federal tax purposes, a partner relationship must be established and certain requirements must be met. For information on these requirements, see Family Partnership in Publication 541. Merely doing chores, helping with the harvest, or keeping house and cooking for the family and hired help does not establish a partnership.

If a husband and wife are partners in a farm operation or other business, they should report their partnership income or loss on Form 1065. See Form 1065, later.

Co-ownership and sharing expenses. Mere co-ownership of property that is maintained and leased does not constitute a partnership. For example, if an individual owner or tenants-in-common of farm property lease that property for a cash rental or a share of the crops, a partnership is not necessarily created by the leasing. However, tenants-in-common may be partners if they actively carry on a farm or other business operation and share its profits and losses. A joint undertaking merely to share expenses is not a partnership.

Partner's distributive share. Each partner's distributive share of partnership income, gain, loss, etc., must be included on that partner's tax return, even if the items were not distributed.

Self-employment tax. Unless you are a limited partner, your distributive share of income from a partnership is self-employment income. If you and your spouse are partners, each should report his or her share of partnership income or loss on a separate Schedule SE (Form 1040), Self-Employment Tax. This will give each of you credit for social security earnings on which retirement benefits are based. The self-employment tax of a member of a partnership engaged in farming is discussed in chapter 15.

Selling or exchanging a partnership. When you create a partnership, you generally do not recognize gain or loss on contributions of money or property you make to the partnership. However, you generally recognize gain or loss when you sell or exchange your interest in the partnership.

You may be able to avoid recognizing gain or loss when ending a partnership if you buy out your partners or change to a corporation status.

Form 1065. Partnerships file a return on Form 1065, U.S. Return of Partnership Income. This is an information return showing the income and deductions of the partnership, the name and address of each partner, and each partner's distributive share of income, gain, loss, deductions, credits, etc. No tax is due on Form 1065.

Form 1065 is not required until the first tax year the partnership has income or deductions. In addition, it is not required for any tax year a partnership has no income and expenses.

Schedule F (Form 1040). Use Schedule F (Form 1040) to report a farm partnership profit or loss. This schedule should be filed with Form 1065. The profit or loss shown on Schedule F, adjusted for amounts to be reported on Schedule K-1 and Schedule K of Form 1065, is entered on line 5 of Form 1065.

Other schedules. Each partner's distributive share of partnership items, such as ordinary income or loss, capital gain or loss, net earnings from self-employment, etc., is entered on Schedule K-1 of Form 1065. Fill in all other schedules listed on Form 1065 that apply to the partnership.

Filing penalty. A penalty is assessed against a partnership that is required to file a partnership return in the following situations.

• The return is not filed on time, including extensions.
• The return does not show all the information required.

The penalty is $50 times the total number of partners for each month (or part of a month) the return is late or incomplete, up to 5 months.

Exception to filing penalty. A partnership does not have to pay the penalty if it can show reasonable cause for failure to file a return. A small farm partnership with 10 or fewer partners is generally considered to meet this requirement if the following information can be shown.

• All partners have reported their entire share of all partnership items on timely filed income tax returns.
• All partners are individuals (other than nonresident aliens), deceased partners' estates, or C corporations.
• The partnership has not elected to be subject to the rules for "consolidated audit procedures."

Consolidated audit procedures. In a consolidated audit proceeding, the tax treatment of any partnership item is generally determined at the partnership level, rather than at the individual partner's level. After the proper tax treatment is determined at the partnership level, the IRS can automatically make related adjustments to the tax returns of the partners, based on their share of the adjusted items.

More information. For more information on partnerships, see Publication 541.

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