A partnership is the relationship between two or more people to do trade or business, where each person contributes money, property, labor or skill, and shares in the profits and losses of the business (IRS, Partnerships). Under state law it can come into existence from conduct alone, without anyone signing anything.
That is the part worth knowing first. Most entity questions start with a filing. This one starts with what people actually did.
The Code Defines It Broadly, Twice
The tax definition is written to catch arrangements rather than to describe a form. For purposes of that subtitle, the term partnership includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a corporation or a trust or estate (26 U.S.C. 761(a)).
The general definitions section says the same thing and adds the partner half. The term partnership includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation, and the term partner includes a member in such a syndicate, group, pool, joint venture, or organization (26 U.S.C. 7701(a)(2)).
Two features of both sentences do the work. Includes is an expanding word, so the listed forms are examples rather than a closed set. And the definition is written negatively at the end: whatever the arrangement is, it is a partnership for these purposes if it is not a corporation, a trust or an estate.
Partner has its own definition with a rule attached. For purposes of that subtitle the term partner means a member of a partnership, and in the case of a capital interest in a partnership in which capital is a material income-producing factor, whether a person is a partner with respect to that interest shall be determined without regard to whether the interest was derived by gift from any other person (26 U.S.C. 761(b)).
State Law Can Form One Without Intent
Formation is state law, so this is stated from one state’s act rather than as a national rule. Delaware’s is the Delaware Revised Uniform Partnership Act, and its formation section has two limbs that are easy to run together.
Except as otherwise provided in subsection (b) of that section, the association of 2 or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership, and the association of 2 or more persons to carry on any purpose or activity not for profit forms a partnership when the persons intend to form one (6 Del. C. section 15-202(a)).
The two limbs run on opposite rules. For a business carried on for profit, intent is irrelevant. For a not-for-profit purpose, intent is the test. Reading only the first half and generalising it, or reading only the second, gets one of the two cases exactly backwards.
There is a limit on what the chapter reaches. Subject to another section of the title, an association formed under a statute other than that chapter, a predecessor statute, or a comparable statute of another jurisdiction, is not a partnership under that chapter (6 Del. C. section 15-202(b)). An entity formed under a different act is that other thing.
The act also settles the entity question. A partnership is a separate legal entity which is an entity distinct from its partners unless otherwise provided in a statement of partnership existence or a statement of qualification and in a partnership agreement (6 Del. C. section 15-201(a)). And a limited liability partnership continues to be the same partnership that existed before the filing of a statement of qualification (6 Del. C. section 15-201(b)), which is the mechanism described in limited liability partnership.
Some Arrangements Can Elect Out
This is the provision most summaries of partnership taxation leave out entirely, and it is in the same subsection as the definition.
Under regulations, the Secretary may, at the election of all the members of an unincorporated organization, exclude that organization from the application of all or part of subchapter K, if it is availed of for investment purposes only and not for the active conduct of a business, or for the joint production, extraction, or use of property but not for the purpose of selling services or property produced or extracted, or by dealers in securities for a short period for the purpose of underwriting, selling, or distributing a particular issue of securities (26 U.S.C. 761(a)(1) to (3)).
The election carries a condition that sits after the list and applies to all three grounds: it is available only if the income of the members of the organization may be adequately determined without the computation of partnership taxable income (26 U.S.C. 761(a)). Three grounds and one condition, and all of them have to be satisfied together.
Note also that the election is at the election of all the members, and that what it excludes is all or part of the subchapter.
What the Entity Files, and What It Does Not Pay
A partnership must file an annual information return to report the income, deductions, gains, losses and so on from its operations, but it does not pay income tax, instead it passes through profits or losses to its partners, and each partner reports their share of the partnership’s income or loss on their personal tax return (IRS, Partnerships). The Code provisions behind that treatment are 26 U.S.C. 701 and 26 U.S.C. 702, and they are set out in pass-through entities.
One consequence catches firms out at payroll rather than at the return. Partners are not employees and shouldn’t be issued a Form W-2, and the partnership must furnish copies of Schedule K-1 (Form 1065) to the partner (IRS, Partnerships).
The entity is still an employer for its actual employees. The IRS lists Form 941 for employment taxes, Form 943 for agricultural employees, and Form 940 for federal unemployment tax among the forms a partnership as an entity may need to file (IRS, Partnerships).
Common Questions
Under the Delaware act, yes, for a business carried on for profit. The association of 2 or more persons to carry on as co-owners a business for profit forms a partnership whether or not the persons intend to form a partnership (6 Del. C. section 15-202(a)). Other states have their own acts, so the operative text is the one for the state in question.
No, they start from different statutes. An LLC is formed under a state’s limited liability company act, described in LLC, and a multi-member LLC is then classified as a partnership for federal income tax purposes by default rather than being one under state law. The tax definition is wide enough to cover both, because it includes any unincorporated organization through which a business, financial operation, or venture is carried on (26 U.S.C. 761(a)).
Not on its own income. It files an annual information return and passes profits or losses through to its partners (IRS, Partnerships). It can still owe employment taxes as an employer, and a state-level entity tax is a separate question covered in PTET tax.
At two points, and the first is the one nobody bills for. A client who describes an arrangement as a handshake, a joint venture or “we split it” may have formed a partnership under state law without intending to, and if the tax definition also reaches it there is a return nobody has been filing. The second point is the payroll question: a working owner who has been paid through payroll and issued a wage statement has been reported in a way the IRS says does not apply to partners.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can run a real block of its own entity return preparation and review work through a trial task before anything client facing depends on it.
