Partners fill out the Partnership Tax Preparation Form.
A partnership is a business with two or more owners who actively engage in the management of the company and divide profits.
Who’s A Good Candidate? When two or more people elect to conduct business together, a general partnership is a relatively easy form of business to set up. Forming a partnership, especially when only two individuals are involved, is often done through a verbal agreement but it is important to create a valid, written partnership agreement as soon as possible.
• Partnerships are easy to establish since anyone or any entity can be a partner
• No double taxation; profits and losses flow directly through to the partners’ personal tax returns
• Offer different classes of ownership shares
• Able to distribute property to partners in a tax-deferred manner
• Partners are jointly and individually liable for the actions of the other partners, whether they knowledgeably or knowingly obligate the business
• Profits must be shared
• Some employee benefits are not deductible from business income on tax returns
• Earnings of partners are subject to self-employment taxes
• Flexible structure can complicate accounting and tax preparation preparing
Partnerships are formed under state partnership statutes. Essentially, there are two broad classifications of partnerships.
General Partnerships (GP)
In general partnerships, partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal partnership agreement. Equal shares are assumed unless there is a written agreement that states differently.
Limited Partnerships (LP)
The designation “limited” simply means that some partners have limited liability (to the extent of their investment) as well as limited input regarding management decisions. This type of arrangement generally encourages investors for short-term projects, or for investing in capital assets.
Qualified Joint Venture
Spouses that conduct a business together and share in the profits and losses are generally classified as a partnership for federal tax purposes. Previously, married individuals in a business together were considered partners and required to file an annual Form 1065, as well as Form 1040.
How’s this done? (1) Income and losses from the business are reported on Form 1065; (2) Each spouse then carries their share of the partnership income or loss from Schedule K-1 to their joint or separate Form(s) 1040; (3) All income, gains, losses, deductions, and credits, under this elect tax treatment are then divided based on each spouse’s interest in the partnership.
Couples may elect out of partnership reporting, and opt for treatment as a qualified joint venture. For tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 (Public Law 110-28) provides that a “qualified joint venture,” whose only members are a married couple filing a joint return, can elect not to be treated as a partnership for federal tax purposes.
A qualified joint venture conducts a trade or business where:
• the only members of the joint venture are a married couple who file a joint return,
• both spouses materially participate in the trade or business (mere joint ownership of property is not enough),
• both spouses elect not to be treated as a partnership, and
• the business is co-owned by both spouses (and not in the name of a state law entity, such as a partnership or LLC).
The QJV option simplifies the filing requirements by allowing a married couple to treat the business as sole proprietorships, and file a Form 1040 federal tax return, rather than a partnership for tax purposes. It eliminates filing a Form 1065 tax return for qualified joint ventures. The option also helps to ensure each spouse gets proper Social Security credit. Spouses electing qualified joint venture status are treated as sole proprietors for federal tax purposes.
• Each spouse has a 50% membership in a partnership which has an income of $100,000, expenses of $70,000, and profit of $30,000.
• A Schedule C is prepared for each spouse, showing $50,000 in income, $35,000 in expenses, and $15,000 in profit.
• The total profit of $30,000 is shown as business income or (loss) on Form 1040, with the two Schedule C forms as supporting documents.
While the IRS allows family members to be partners, it does place some limits on “keeping it in the family.” The IRS will only recognize family members (or any other persons) as partners if one of the following is met:
• If capital is a material income-producing factor, they must have (1) acquired this capital interest in a bona fide
transaction (including gift or purchase), and (2) have actually owned and controlled the partnership interest.
• Capital is considered a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital.
• If capital is not a material income-producing factor, they must have (1) joined in good faith to conduct business, (2) agreed that contributions of each entitle them to a share in the profits, and (3) each provided some capital or service.
• Capital is not a material income-producing factor if business income consists primarily of fees, commissions, or other compensation for personal services performed by members or employees of the partnership.
• If a family member 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 the following two 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 from donated capital must not be proportionately greater than the donor’s share from the donor’s capital.