Publication 541 |
2000 Tax Year |
Forming a Partnership
The following sections contain general information about
partnerships.
Organizations Classified as Partnerships
An unincorporated organization with two or more members is
generally classified as a partnership for federal tax purposes if its
members carry on a trade, business, financial operation, or venture
and divide its profits. However, a joint undertaking merely to share
expenses is not a partnership. For example, co-ownership of property
maintained and rented or leased is not a partnership unless the
co-owners provide services to the tenants.
The rules you must use to determine whether an organization is
classified as a partnership changed for organizations formed after
1996.
Organizations formed after 1996.
An organization formed after 1996 is classified as a partnership
for federal tax purposes if it has two or more members and it is none
of the following.
- An organization formed under a federal or state law that
refers to it as a corporation, body corporate, or body politic.
- An organization formed under a state law that refers to it
as a joint-stock company or joint-stock association.
- An insurance company.
- Certain banks.
- An organization wholly owned by a state or local
government.
- An organization specifically required to be taxed as a
corporation by the Internal Revenue Code (for example, certain
publicly traded partnerships).
- Certain foreign organizations.
- A tax-exempt organization.
- A real estate investment trust.
- An organization classified as a trust under section
301.7701-4 of the regulations or otherwise subject to special
treatment under the Internal Revenue Code.
- Any other organization that elects to be classified as a
corporation by filing Form 8832.
For more information, see the instructions for Form 8832,
Entity Classification Election.
Limited liability company.
A limited liability company (LLC) is an entity formed under state
law by filing articles of organization as an LLC. Unlike a
partnership, none of the members of an LLC are personally liable for
its debts. An LLC may be classified for federal income tax purposes as
either a partnership, a corporation, or an entity disregarded as an
entity separate from its owner by applying the rules in regulations
section 301.7701-3. See Form 8832 for more details.
Organizations formed before 1997.
An organization formed before 1997 and classified as a partnership
under the old rules will generally continue to be classified as a
partnership as long as the organization has at least two members and
does not elect to be classified as a corporation by filing Form 8832.
Family Partnership
Members of a family can be partners. However, family members (or
any other person) will be recognized as partners only if one of the
following requirements is met.
- If capital is a material income-producing factor, they
acquired their capital interest in a bona fide transaction (even if by
gift or purchase from another family member), actually own the
partnership interest, and actually control the interest.
- If capital is not a material income-producing factor, they
joined together in good faith to conduct a business. They agreed that
contributions of each entitle them to a share in the profits, and some
capital or service has been (or is) provided by each partner.
Capital is material.
Capital is a material income-producing factor if a substantial part
of the gross income of the business comes from the use of capital.
Capital is ordinarily an income-producing factor if the operation of
the business requires substantial inventories or investments in
plants, machinery, or equipment.
Capital is not material.
In general, capital is not a material income-producing factor if
the income of the business consists principally of fees, commissions,
or other compensation for personal services performed by members or
employees of the partnership.
Capital interest.
A capital interest in a partnership is an interest in its assets
that is distributable to the owner of the interest in either of the
following situations.
- The owner withdraws from the partnership.
- The partnership liquidates.
The mere right to share in earnings and profits is not a capital
interest in the partnership.
Gift of capital interest.
If a family member (or any other person) receives a gift of a
capital interest in a partnership in which capital is a material
income-producing factor, the donee's distributive share of partnership
income is subject to both of the following restrictions.
- It must be figured by reducing the partnership income by
reasonable compensation for services the donor renders to the
partnership.
- The donee's distributive share of partnership income
attributable to donated capital must not be proportionately greater
than the donor's distributive share attributable to the donor's
capital.
Purchase.
For purposes of determining a partner's distributive share, an
interest purchased by one family member from another family member is
considered a gift from the seller. The fair market value of the
purchased interest is considered donated capital. For this purpose,
members of a family include only spouses, ancestors, and lineal
descendants (or a trust for the primary benefit of those persons).
Example.
A father sold 50% of his business to his son. The resulting
partnership had a profit of $60,000. Capital is a material
income-producing factor. The father performed services worth $24,000,
which is reasonable compensation, and the son performed no services.
The $24,000 must be allocated to the father as compensation. Of the
remaining $36,000 of profit due to capital, at least 50%, or $18,000,
must be allocated to the father since he owns a 50% capital interest.
The son's share of partnership profit cannot be more than $18,000.
Husband-wife partnership.
If spouses carry on a business together and share in the profits
and losses, they may be partners whether or not they have a formal
partnership agreement. If so, they should report income or loss from
the business on Form 1065. They should not report the
income on a Schedule C (Form 1040) in the name of one spouse as a sole
proprietor.
Each spouse should carry his or her share of the partnership income
or loss from Schedule K-1 (Form 1065) to their joint or separate
Form(s) 1040. Each spouse should include his or her respective share
of self-employment income on a separate Schedule SE (Form 1040),
Self-Employment Tax. This generally does not increase the
total tax on the return, but it does give each spouse credit for
social security earnings on which retirement benefits are based.
Partnership Agreement
The partnership agreement includes the original agreement and any
modifications. The modifications must be agreed to by all partners or
adopted in any other manner provided by the partnership agreement. The
agreement or modifications can be oral or written.
Partners can modify the partnership agreement for a particular tax
year after the close of the year but not later than the date for
filing the partnership return for that year. This filing date does not
include any extension of time.
If the partnership agreement or any modification is silent on any
matter, the provisions of local law are treated as part of the
agreement.
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