MODULE 35 TAXES: PARTNERSHIPS 523

PARTNERSHIPS

Partnerships are organizations of two or more persons to carry on business, activities for profit. For tax
purposes, partnerships also include a syndicate, joint venture, or other unincorporated business through which
any business or financial operation is conducted. Partnerships do not pay any income tax, but instead act as a
conduit to pass through tax items to the partners. Partnerships file an informational return (Form 1065), and
partners report their share of partnership ordinary income or loss and other items on their individual returns.
The nature or character (e.g., taxable, nontaxable) of income or deductions is not changed by the pass-through
nature of the partnership.
A. Entity Classification
1. Eligible business entities (a business entity other than an entity automatically classified as a
corpora-
tion) may choose how they will be classified, for federal tax' purposes by filing Form 8832. A business
entity with at least two members can choose to be classified as either an association taxable as a cor-
poration or as a partnership. A business entity with a single member can choose to be classified as ei-
ther an association taxable as a corporation or disregarded as an entity separate from its owner.

a. An eligible business entity that does not file Form 8832 will be classified under default rules. Un-
der default rules, an eligible business entity will be classified as a partnership if it has two or more
members, or disregarded as an entity separate from its owner if it has a single owner.

b. Once an entity makes an election, a different election cannot be made for sixty months unless
there is more than a 5Q% ownership change and the IRS consents.

2. General partnerships exist when two or more partners join together and do not specifically
provide
that one or more partners is a limited partner. Since each general partner has unlimited liability,
creditors can reach the personal assets of a general partner to satisfy partnership debts, including a
malpractice judgment against the partnership even though the partner was not personally involved in
the malpractice.

3. Limited partnerships have two classes of partners, with at least one general partner (who has the
same rights and responsibilities as a partner in a general partnership) and at least one limited partner.
A limited partner generally cannot participate in the active management of the partnership, and in the
event of losses, generally can lose no more than his or her own capital contribution. A limited partner-
ship is often the preferred entity of-choice for real estate ventures.requiring significant capital contri-
butions.

4. Limited liability partnerships differ from general partnerships in that with an LLP, a partner is
not
liable for damages resulting from the negligence, malpractice, or fraud committed by other partners.
However, each partner is personally liable for his or her own negligence, malpractice, or fraud. LLPs
are often used by service providers such as architects,accountants, attorneys, and physicians.

5. Limited liability companies that do not elect to be treated as an association taxable as a

corporation
are subject to the rules applicable to partnerships (a single-member LLC would be disregarded as an
entity separate from its owner). An LLC combines the nontax advantage of limited liability for each
and every owner of the entity, with the tax advantage of pass-through treatment, and the flexibility of
partnership taxation. The LLC structure is generally available to both nonprofessional service provid-
ers as well as capital-intensive companies.

6. Electing large partnerships are partnerships that have elected to be taxed under a simplified
report-
ing system that does not require as much separate reporting to partners as does a regular partnership.
For example, charitable contributions are deductible by the partnership (subject to a 10% of taxable
income limitation), and the Sec. 179 expense election is deducted in computing partnership ordinary
income and not separately passed through to partners. To qualify, the partnership must not be a ser-
vice partnership nor engaged in commodity trading, must have at least 100 partners, and must file an
election to be taxed as an electing large partnership. A partnership will cease to be an electing large
partnership if it has fewer than 100 partners for a taxable year.

7. Publicly traded partnerships are partnerships whose interests are traded on an established
·securities
exchange or in a secondary market and are generally taxed as C corporations.