What is a Partnership?
A partnership exists when two or more people carry on a business together for profit. It can be formal (with a written agreement) or informal (two people splitting work and income). The partnership itself doesn't pay income tax — profits and losses pass through to each partner.
How It's Taxed
The partnership files Form 1065 (an information return). Each partner receives a Schedule K-1 showing their share of income, deductions, and credits. Partners report their K-1 on Schedule E of their personal Form 1040.
General partners owe self-employment tax on their share of partnership income. Limited partners generally do not.
Pros
- Pass-through taxation — no entity-level tax, avoiding double taxation
- Flexible allocations — partners can allocate income, losses, and credits with substantial flexibility (must have economic substance)
- Simple formation — no state filing required for general partnerships (though an agreement is strongly recommended)
Cons
- Unlimited liability (general partners) — general partners are personally liable for all partnership debts and obligations
- Partner disagreements — without a clear partnership agreement, disputes can dissolve the business
- SE tax on active partners — general partners pay SE tax on their distributive share
Recommendations
Tip
Most partnerships should be structured as LLCs taxed as partnerships. This gives you partnership tax treatment with LLC liability protection. Form a multi-member LLC and let it default to partnership taxation.
Each partner must track their outside basis in the partnership. This determines how much loss they can deduct and whether distributions are taxable or a return of capital.