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Publication 541




Photographs of missing children.(p1)
The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. 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 does not 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 Publication 535, Business Expenses. Members of oil and gas partnerships should read about the deduction for depletion in chapter 9 of that publication.
Certain partnerships must have a tax matters partner (TMP) who is also a general partner. For information on the rules for designating a TMP, see Designation of Tax Matters Partner (TMP) in the Form 1065 instructions and section 301.6231(a)(7)-1 of the regulations.
Many rules in this publication do not apply to partnerships that file Form 1065-B, U.S. Return of Income for Electing Large Partnerships. For the rules that apply to these partnerships, see the instructions for Form 1065-B. However, the partners of electing large partnerships can use the rules in this publication except as otherwise noted.

Withholding on foreign partner or firm.(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). If a partnership has income effectively connected with a trade or business in the United States, it must withhold on the income allocable to its foreign partners. A partnership may have to withhold tax on a foreign partner's distributive share of fixed or determinable income not effectively connected with a U.S. trade or business. A partnership that fails to withhold may be held liable for the tax, applicable penalties, and interest.
For more information, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.

Comments and suggestions.(p2)

We welcome your comments about this publication and your suggestions for future editions.
You can write to:

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

We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.
You can send us comments from Click on "More Information" and then on "Comment on Tax Forms and Publications."
Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products.
Tax questions.(p2)
If you have a tax question, check the information available at or call 1-800-829-4933. We cannot answer tax questions at the address listed above.
Ordering forms and publications.(p2)
Visit to download forms and publications, call 1-800-829-3676, or write to one of the addresses shown under How To Get Tax Help in the back 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 near 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.(p2)
A limited liability company (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 does not file Form 8832 is classified as a partnership for federal income tax purposes.

Organizations formed before 1997.(p2)

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 does not elect to be classified as a corporation by filing Form 8832.

Community property.(p2)

Spouses who own a qualified entity (defined later) 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 Publication 555, Community Property. Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Family Partnership(p2)

Members of a family can be partners. However, family members (or any other person) will be recognized as partners only if one of the following requirements is met.

Capital is material.(p3)

Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment.

Capital is not material.(p3)

In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership.

Capital interest.(p3)

A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations.
The mere right to share in earnings and profits is not a capital interest in the partnership.

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.
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).


A father sold 50% of his business to his son. The resulting partnership had a profit of $60,000. Capital is a material income-producing factor. The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. The $24,000 must be allocated to the father as compensation. Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. The son's share of partnership profit cannot be more than $18,000.

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 does not 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 (i.e., 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 does not 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, enter "Election for Qualified Joint Ventures" in the search box and select the link reading "Election for Husband and Wife Unincorporated Businesses."

Partnership Agreement(p3)

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 does not 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.