A partnership is an association of two or more persons for the purpose of conducting business, with each contributing money, property, labor, or skill, and with all expecting to share in PROFITs and losses. Partners can be individuals, CORPORATIONs, estates partnerships, or TRUSTs. The federaltaxation advantage in the partnership form of business is that partnership losses generally pass through to the partners for deduction on their tax returns (subject to basis, atrisk, and passive limitations described below), whereas partnership gains are not subject to double taxation (as they are in the corporate form of business). The term partnership includes a syndicate, group, pool, joint venture, or other entity that exists for the purpose of making a profit in a business or financial operation. The rights and responsibilities of the individual partners include (1) the right of each partner to act as an agent of the partnership (mutual agency); (2) the personal responsibility of each partner for the debts of the partnership (unlimited LIABILITY); (3) the termination of the partnership by the withdrawal, death, insanity, or bankruptcy of any partner (limited life); and (4) the right to share profits in some mutually agreeable manner (profit motive). The partnership form of business allows a great degree of flexibility in the conduct of an enterprise. Partnerships generally operate as general partnerships, limited partnerships, LIMITED LIABILITY PARTNERSHIPs, or limited liability companies. All four enjoy pass-through taxation and thus avoid the double taxation inherent in a corporation’s division of profits (as DIVIDENDS). A general partnership has two or more partners who share ownership, profits, losses, and liability. Although one or more of the partners manage the day-to-day affairs of the partnership, they still share equally the profits, losses, and liability for DAMAGES caused by employees or partners. General partners are often required to sign personal guarantees for business and equipment leases and bank lines of credit. Each partner has full authority to bind the partnership. In essence, one partner can make each of the other partners liable on business and equipment leases and bank lines of credit (joint and several liability). No one may join a partnership without the approval of a majority of the existing partners. A limited partnership has one or more limited partners in addition to at least one general partner. Typically only the general partners are liable to creditors; each limited partner’s risk of loss is restricted to that partner’s EQUITY investment in the entity. Limited partners by definition are not involved in the MANAGEMENT of the partnership enterprise. A limited partnership is often used for acquiring CAPITAL in activities such as real-estate development. Partners in a limited liability partnership (LLP) are treated much like general partners, with the exception that an LLP partner is not liable for torts or malpractice committed by the other partners. The LLP partners are liable for the other partners’ CONTRACT violations. A LIMITED LIABILITY COMPANY (LLC) combines the best features of a partnership and a corporation, even though it is neither. It is taxed like a partnership while providing the limited liability of a corporation; this limited liability extends to all the LLC owners, called members. Similar to an unlimited partnership with no general partners, the LLC can elect to be taxed as either a corporation or a partnership under check-the-box regulations, but most LLCs elect to be taxed as a partnership. The LLC entity form protects the members from both tort liabilities arising from the actions of other members as well as any liabilities arising from CONTRACTs entered into by other members. Members are always liable for their own tort and contract acts as well as for the acts of others under their direction. Partnership taxation blends the entity concept with the aggregate concept, with the central tax advantage being that the partnership items of net INCOME or loss flow through (pass through) to the partners’ tax returns. The partnership files a Form 1065 as an information report to the INTERNAL REVENUE SERVICE (IRS), but partnerships do not pay any tax. The tax is paid by the partners, with the information reported on the Form 1065 K-1 filed for each partner disclosing the partner’s name and federal identifying number (e.g., SOCIAL SECURITY number or employer’s ID number). Approximately 2 million partnership returns are filed with the IRS annually. The tax law addressing the transaction of partners and partnerships is found in Subchapter K of the Internal Revenue Code. However, most partnership tax-law details have evolved through extensive IRS regulations and a large number of court cases. In many cases, a partnership may be formed and liquidated tax-free. Immediately after its formation, a partner’s basis in the partnership interest is the carryover basis of the amounts contributed to the partnership, less the share of debt assumed by the other partners, plus the share of partnership debt assumed by the contributing partner. During the life of a partnership (or an LLC electing to be taxed as a partnership), the partners are taxed on the distributive share of partnership income, whether or not the amount is actually received by the partner. The income and loss items are added and subtracted to the partner’s basis in the partnership interest. Withdrawals by a partner are not taxed as long as the partner has sufficient basis in the partnership interest (capital recovery concept). The partner’s basis in the partnership interest is reduced by the distributions received from the partnership. The partner’s share of partnership losses are passed through for potential deduction on the individual partner’s return. The partner’s ability to reduce his/her taxable income with this allocated loss will depend on (1) the partner’s basis in the partnership interest, (2) the partner’s at-risk basis, and (3) the partner’s passive-loss limitations. In many cases a loss will not be allowable for a given year because of these restrictions, and the partner will then carry the loss forward into a future year for potential deductibility. The LLC and LLP are existing new forms of business that are able to combine partnership taxation, limited liability, and flexible management. As a result of this development, many businesses organized after the late 1990s will be taxed as partnerships. Many businesses organized before that time are C and S corporations, and will continue to operate in the C or S corporation form due in part of the tax cost of liquidating these corporate entities.
See also JOINT VENTURES; S CORPORATION.