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Publication 541



What’s New(p1)

Technical terminations.(p1)
Technical terminations do not apply for partnership tax years beginning after 2017.
Bipartisan Budget Act.(p1)
The Bipartisan Budget Act of 2015 (BBA) created a new centralized partnership audit regime effective for partnership tax years beginning after 2017.
Electing large partnerships.(p1)
The BBA repealed the electing large partnership rules for partnership tax years beginning after 2017.
Partnership representative.(p1)
Under the centralized partnership audit regime, partnerships are generally required to designate a partnership representative. See Role of Partnership Representative, later.
Electing out of the centralized partnership audit regime.(p1)
A partnership can elect out of the centralized partnership audit regime for a tax year if the partnership is an eligible partnership that year. See Electing Out of the Centralized Partnership Audit Regime, later.
Business interest expense limitation.(p1)
Public Law 115-97 amended section 163(j) to reflect a limitation on business interest expense. For tax years beginning after 2017, a business interest expense deduction may be limited for certain taxpayers. The Instructions for Form 8990, Limitation on Business Interest Expense Under Section 163(j), explain when a business interest expense deduction is limited, who is required to file Form 8990, and how certain businesses may elect out of the business interest expense limitation.


Photographs of missing children.(p2)
The Internal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.


This publication provides supplemental federal income tax information for partnerships and partners. It supplements the information provided in the Instructions for Form 1065, U. S. Return of Partnership Income, and the Partner's Instructions for Schedule K-1 (Form 1065). Generally, a partnership doesn't pay tax on its income but "passes through" any profits or losses to its partners. Partners must include partnership items on their tax returns.
For a discussion of business expenses a partnership can deduct, see Pub. 535, Business Expenses. Members of oil and gas partnerships should read about the deduction for depletion in chapter 9 of that publication.
For tax years beginning before 2018, certain partnerships must have a tax matters partner (TMP) who is also a general partner.
The TMP has been replaced with partnership representative for partnership tax years beginning after 2017. Each partnership must designate a partnership representative unless the partnership has made a valid election out of the centralized partnership audit regime. See Designated partnership representative in the Form 1065 instructions and Regulations section 301.6223-1.

Withholding on foreign partner or firm.(p2)

A partnership that has foreign partners or engages in certain transactions with foreign persons may have one (or more) of the following obligations.
Fixed or determinable annual or periodical (FDAP) income.(p2)
A partnership may have to withhold tax on distributions to a foreign partner or a foreign partner’s distributive share when it earns income not effectively connected with a U.S. trade or business. A partnership may also have to withhold on payments to a foreign person of FDAP income not effectively connected with a U.S. trade or business. See section 1441 or 1442 of the Internal Revenue Code.
Withholding under the Foreign Investment in Real Property Tax Act (FIRPTA).(p2)
If a partnership acquires a U.S. real property interest from a foreign person or firm, the partnership may have to withhold tax on the amount it pays for the property (including cash, the fair market value of other property, and any assumed liability). See section 1445 of the Internal Revenue Code.
Withholding on foreign partner’s effectively connected taxable income (ECTI).(p2)
If a partnership has income effectively connected with a trade or business in the United States (including gain on the disposition of a U.S. real property interest), it must withhold on the ECTI allocable to its foreign partners. See section 1446(a) of the Internal Revenue Code.
Withholding on foreign partner’s sale of a partnership interest.(p2)
A purchaser of a partnership interest, which may include the partnership itself, may have to withhold tax on the amount realized by a foreign partner on the sale for that partnership interest if the partnership is engaged in a trade or business in the United States. See section 1446(f) of the Internal Revenue Code.
Withholding under the Foreign Account Tax Compliance Act (FATCA).(p2)
A partnership may have to withhold tax on distributions to a foreign partner of a foreign partner’s distributive share when it earns withholdable payments. A partnership may also have to withhold on withholdable payments that it makes to a foreign entity. See sections 1471 through 1474 of the Internal Revenue Code. A partnership that has a duty to withhold but fails to withhold may be held liable for the tax, applicable penalties, and interest. See section 1461 of the Internal Revenue Code.

Comments and suggestions.(p2)

We welcome your comments about this publication and your suggestions for future editions.
You can send us comments through Or you can write to:

Internal Revenue Service
Tax Forms and Publications
1111 Constitution Ave. NW, IR-6526
Washington, DC 20224

Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax forms, instructions, and publications.
Ordering forms and publications.(p2)
Visit to download forms and publications. Otherwise, you can go to to order current and prior-year forms and instructions. Your order should arrive within 10 business days.
Tax questions.(p2)
If you have a tax question not answered by this publication, check and How To Get Tax Help at the end of this publication.


Useful items

You may want to see:

 334 Tax Guide for Small Business
 505 Tax Withholding and Estimated Tax
 535 Business Expenses
 537 Installment Sales
 538 Accounting Periods and Methods
 544 Sales and Other Dispositions of Assets
 551 Basis of Assets
 925 Passive Activity and At-Risk Rules
 946 How To Depreciate Property
See How To Get Tax Help at the end of this publication for information about getting publications and forms.

Forming a Partnership(p2)

The following sections contain general information about partnerships.

Organizations Classified as Partnerships(p2)

An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership. For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.
The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996.

Organizations formed after 1996.(p2)

An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. For more information, see the Instructions for Form 8832.
Limited liability company (LLC).(p2)
An LLC is an entity formed under state law by filing articles of organization as an LLC. Unlike a partnership, none of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301.7701-3. See Form 8832 and section 301.7701-3 of the regulations for more details.
A domestic LLC with at least two members that doesn't file Form 8832 is classified as a partnership for federal income tax purposes.

Organizations formed before 1997.(p3)

An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and doesn't elect to be classified as a corporation by filing Form 8832.

Community property.(p3)

Spouses who own a qualified entity (defined below) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. A change in reporting position will be treated for federal tax purposes as a conversion of the entity.
A qualified entity is a business entity that meets all the following requirements.
For more information about community property, see Pub. 555, Community Property. Pub. 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Partnership Interests Created by Gift(p3)


Gift of capital interest.(p3)

If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions.

Purchase considered gift.(p3)

For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. The fair market value of the purchased interest is considered donated capital. For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons).

Partnership Interests Held in Connection With Performance of Services(p3)

For tax years beginning after 2017, to get long-term capital gain treatment for certain gains attributable to "applicable partnership interests," the required asset holding period is greater than 3 years. Under section 1061 of the Internal Revenue Code, the amount of the taxpayer’s net long-term capital gain with respect to applicable partnership interests for the tax year that exceeds the amount of such gain figured as if a 3-year (not 1-year) holding period applies is treated as short-term capital gain. Net long-term capital gain is the net of long-term capital gain over long-term capital loss.

Applicable partnership interest.(p3)

An applicable partnership interest is any interest in a partnership that, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer, or any other related person, in any "applicable trade or business." The special recharacterization rule applies to:
  1. Capital gains recognized by a partner from the sale or exchange of an applicable partnership interest under Internal Revenue Code sections 741(a) and 731(a); and
  2. Capital gains recognized by a partnership, allocated to a partner with respect to an applicable partnership interest.

Applicable trade or business.(p3)

An applicable trade or business means any activity conducted on a regular, continuous, and substantial basis (regardless of whether the activity is conducted through one or more entities) which consists in whole or in part of:

Specified assets.(p3)

Specified assets are:


A security for this purpose means any of the following.

Business Owned and Operated by Spouses(p3)

If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. If so, they should report income or loss from the business on Form 1065. They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. However, the spouses can elect not to treat the joint venture as a partnership by making a qualified joint venture election.

Qualified Joint Venture Election(p3)

A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. A qualified joint venture conducts a trade or business where the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC.
Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore doesn't have a Form 1065 filing requirement. All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (that is, based on their respective interests in the venture).
If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax.
This generally doesn't increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation.
For more information on qualified joint ventures, go to

Partnership Agreement(p4)

The partnership agreement includes the original agreement and any modifications. The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. The agreement or modifications can be oral or written.
Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. This filing date doesn't include any extension of time.
If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement.