Partnership Defined

A partnership is the relationship between two or more entities who join together to carry on a trade or business. An entity, when used in this context, may refer to an individual, a corporation, a trust, an estate, or another partnership.

• For federal tax purposes, the term "partnership" includes a syndicate, group, pool, or joint venture that is carrying on a trade or business and is not classified as a trust, an estate, a qualified joint venture, or a corporation.
  • Per-se corporations, such as insurance companies, cannot be classified as partnerships.
  • Tax-exempt organizations cannot be classified as partnerships.
  • A domestic limited liability company (LLC) with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes.
• An agreement to share expenses does not constitute a partnership.
• Co-ownership of rental property is not a partnership unless services are provided to the tenants. Two brothers who inherit a building and split the rent each report on Schedule E, not on a 1065.
• A partnership is allowed to be excluded from treatment as a partnership if it is not in the active conduct of a business, for example, a partnership of individuals who pool their money for investment purposes (the Sec. 761(a) election).
  • All partners must elect for this treatment to apply.
  • Each member must separately include his or her share of the income and deductions.
• A single-member domestic LLC is treated as a disregarded entity but alternatively may elect treatment as a corporation for tax purposes.
• An interest in a partnership has no determinable useful life and cannot be depreciated or amortized; it is specifically excluded from Sec. 197.

Partnership Agreement

• A partnership agreement includes the original agreement that determines the partner's share of income, gains, losses, deductions, and credits.
  • The agreement must be agreed to by all partners.
  • The agreement must have substantial economic effect; otherwise, the allocation will be made based on the partner's interest in the partnership.
    • There must be a reasonable possibility that the allocation will substantially affect the dollar amount of the partner's share of ownership.
    • The partner to whom an allocation is made actually receives the economic benefit or burden corresponding to that allocation.
  • The simplest way to change a partner's share is to amend the agreement; an amendment made by the due date of the return (without extensions) applies to the whole year.
• If the agreement does not allocate an item, the partner's interest in the partnership is determined from the partners' relative contributions, their interests in economic profits and losses and in cash flow and other nonliquidating distributions, and their rights to capital on liquidation. The amount of nonrecourse debt is not a factor.

Family Partnership

• A family partnership is one consisting of a taxpayer and his or her spouse, ancestors, lineal descendants, or trusts for the primary benefit of any of them. Siblings are not treated as members of the taxpayer's family for these purposes. Income or loss from a family partnership should be reported on Form 1065 rather than on Schedule C of Form 1040.
  • For family members to be recognized as partners in a family partnership, one of the following requirements must be 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.
  • Services. A services partnership is one in which capital is not a material income-producing factor.
    • In a family partnership, a family member is treated as a services partner only to the extent (s)he provides services that are substantial or vital to the partnership.
  • Capital. A family member is treated as a partner in a partnership in which capital is a material income-producing factor.
    • However, the partnership agreement is disregarded to the extent a partner receives less than reasonable compensation for services.

• • • The recipient of gifted interest may not receive income greater than the proportionate share of the donor.
    • This rule applies to all, not just some, family members.
  • Spouses filing a joint return may elect out of partnership treatment by choosing to be a qualified joint venture.
    • The only members of the joint venture must be the spouses, and both must materially participate and make the election.
    • Each spouse will be treated as a sole proprietor, allowing both to receive Social Security benefits.
    • All items of income, gain, loss, deduction, and credit attributable to the business must be divided between the spouses in accordance with each spouse's respective interest in the joint venture.
    • added 2026 The qualified joint venture is not available to a state-law LLC owned by spouses except in a community-property state (Rev. Proc. 2002-69). Colorado is not one, so a husband-and-wife Colorado LLC files a 1065.

Constructive Ownership — Partnership Interest

• An individual is treated as owning the interest owned by his or her spouse, brothers and sisters, children, grandchildren, and parents.
  • An interest directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered to be owned proportionately by or for its shareholders, partners, or beneficiaries.
  • If 50% or more in value of a corporation's stock is owned, directly or indirectly, by or for a person, that person is considered to own the partnership interest owned by the corporation in proportion to the value of the stock (s)he owns.

    Note. The partnership rules (Sec. 267 and Sec. 707(b)) include siblings. The Sec. 318 rules for stock redemptions do not include siblings, aunts or uncles, and they attribute stock from a partnership to its partners regardless of the partner's percentage.

Private reference, not client advice. Original notes written 2022–2023 while studying for the SEE Part 2; figures updated October 2026 (Rev. Proc. 2025-32, Rev. Proc. 2026-15, P.L. 119-21). Verify current-year amounts before relying on them.