A partnership is an unincorporated joint venture by two or more persons to carry on a business as co-owners for profit. It is one of the most popular formats (although S-corporations may surpass them) and like S-corporations, are passthrough entities. The tax liability passes through to the individual partners, members, or shareholders.
Some states have other forms of entity organization, such as limited liability companies (LLC) or limited liability partnerships (LLP). These forms are usually taxed as partnerships, unless the entity elects otherwise, or in the case of a single member LLC, it is regarded as a sole proprietorship with limited liability.
There are no formal legal requirements to start a general partnership. Thus, any two or more individuals who get involved in a business or financial undertaking automatically become a partnership for tax purposes. The minimum requirements to begin a partnership simply are:
- Have two or more owners;
- Actively conduct a business; and
- Operate with profit motive.
Since a partnership and corporation share the same mandatory characteristics, the IRS or courts used to look at the attributes of a business association to determine whether it more closely resembled a partnership or a corporation. Not anymore. The IRS now automatically views the business as a partnership unless the owners elect to be taxed as a corporation by checking the appropriate box on their tax return.
(It should be noted that some states have non-tax rules concerning partnerships that should also be investigated.)
Partnership Agreements
The Uniform Partnership Act defines a general partnership as "an association of two or more persons to carry on as co-owners a business for profit." This can be orally or in writing.
Even though not required, creating a written partnership agreement is highly advisable. A proper partnership agreement governs the relationship between the partners. It states any special allocations of income, deductions, gains, or losses to the partnership for tax purposes. It spells out:
- The death of a partner;
- The withdrawal of a partner;
- Any restrictions on the sale a partnership interest; and
- The dissolution of the partnership