Federal Tax

Partnerships—Conceptual Overview (Portfolio 710)

  • This Portfolio provides a conceptual overview of the federal income tax treatment of partnerships under Subchapter K of the Internal Revenue Code.


Bloomberg Tax Portfolio, Partnerships — Conceptual Overview, No. 710, provides a conceptual overview of the federal income tax treatment of partnerships under subchapter K of the Internal Revenue Code. This includes not only an analysis of the relevant statutory and regulatory materials, but also the large body of case law, revenue rulings, and other IRS pronouncements, including technical advice memoranda and private letter rulings, that are all part of this complex body of tax law.

The dual nature of a partnership for tax purposes — at times an aggregation of its partners, and at times an entity — complicates partnership taxation, particularly because no one, including the author, has been able to articulate a comprehensive statement of when the aggregate aspect and when the entity aspect should predominate. The Portfolio highlights some of the major applications of the aggregate and entity principles in partnership taxation, as an orientation to the principles and structure of Subchapter K, as well as a basis for analyzing partnership problems, for which the authorities provide little meaningful guidance. Partnership taxation is further muddled by the fact that a “tax” partnership includes not only entities organized as general or limited partnerships under state law, but also the newer forms: limited liability partnerships, primarily for professionals, and limited liability companies.

Because most partnership law is a matter of contract among the parties, a major characteristic of the partnership form is its flexibility. Partnership tax principles respect and accommodate that business flexibility, but flexibility can also lead to abuse. Predictably, the Code, the regulations, the IRS, and the courts limit the flexibility. The Portfolio addresses the resulting strains on the application of the aggregate and entity principles, as well as other principles.

The Portfolio examines tax partnerships in detail, distinguishing them from other business relationships. This issue has been simplified by the “check-the-box” regulations that became effective in 1997, and that now allow unincorporated organizations to elect whether to be taxed as partnerships or as associations taxable as corporations. This choice is not available for business entities that are organized as corporations under state law, or for publicly traded partnerships. Special rules apply for foreign entities. Because they remain relevant for controversies involving earlier years, the partnership classification criteria that applied before the check-the-box regulations became effective are summarized. At the other end of the spectrum, partnerships must be distinguished from other relationships that may not constitute business entities, including co-ownership of property, sharing of expenses, and pooling arrangements, as well as employer-employee, debtor-creditor, seller-purchaser, and lessor-lessee relationships. When these other, often informal, arrangements provide for the sharing of profits, they may resemble partnerships. The check-the-box regulations do not apply to these determinations, because they relate to the classification of business entities rather than the determination of whether an arrangement is a business entity. The factors used in determining whether these arrangements are tax partnerships do not necessarily focus on why Subchapter K, or other partnership provisions, should apply. In addition, the election that allows some tax partnerships to be excluded from certain partnership tax provisions is considered.

The Portfolio also provides a general overview of the major federal income tax aspects of conducting business operations through a tax partnership, in the form of a summary statutory outline of the mechanics of partnership taxation, as provided in the Code, regulations, IRS materials, and cases, with an emphasis on the application of aggregate and entity principles. In doing so, it surveys partnership operations according to the following outline: (1) partnership operations generally, and, more specifically, (a) allocating the results of partnership operations among the partners, including according to the special allocation rules, and principles relating to operations financed with nonrecourse liabilities, (b) partnership liabilities, including the allocation of recourse and nonrecourse liabilities, and (c) transactions between partners and partnerships; (2) contributions of property or services by partners, as well as other transactions between partners and partnerships, in properties, and services, including the disguised sale and disguised compensation rules; (3) distributions by partnerships to partners, whether during operations, or in liquidation of the interest of a withdrawing or deceased partner, with an emphasis on the unique nonrecognition provisions; and (4) disposition of partnership interests or partnership businesses, and termination of the partnership.

Table of Contents

I. Introduction
II. Fundamental Concepts and Principles
III. Taxation of Partnerships and Partners: Statutory Outline

Elliott Manning
Professor of Law Emeritus and Dean's Distinguished Scholar for the Profession Emeritus
University of Miami