Partnership

A partnership is an unincorporated Business Entity in which two or more persons join to carry on a business for profit.1

The business owners need not have a formal organizing document (although they should).2 Hence, if a sole proprietor takes in a partner and doesn't formally organize any other form of business entity, the result is a partnership, because a Sole Proprietorship can have only one owner.

Typically, each person in a partnership contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

The biggest tax advantage of using a partnership is that the owners automatically avoid Double Taxation.

Although a partnership must file an annual information return, IRS Form 1065, “U.S. Return of Partnership Income,” to report the income, deductions, gains, losses, etc., from its operations, it does not pay income tax. Instead, it “passes through” any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return. (See also Pass-through Entity.)

Partners are not employees and hence the partnership does not issue a Form W-2 to the partners. However, the partnership must give each partner a copy of the partnership's Schedule K-1, “Partner's Share of Income, Deductions, Credits, etc.” of IRS Form 1065.

A disadvantage of using a partnership is that partners are not eligible for tax-favored fringe benefits.

Husband-and-wife business. Because a legal partnership can be created without formal organizing documents, a husband-and-wife business could be treated as a partnership,3 even if that is not their intention or in their best tax interests. (See also Qualified Joint Venture.)

For articles in our Tax Reduction Letter on tax strategies for husband-and-wife businesses, click on Husband and wife business in our Browse by Topic finding tool.