“What’s a Partnership, you ask? Well, it’s like a business relationship where two or more folks team up to run a trade or business. Each person chips in with money, property, labor, or skills, and they all expect to share in the difficulties of the business.

Now, a partnership files an annual informational return to disclose information on its income, deductions, gains, and losses, but the partnership itself usually doesn’t cough up income tax. Instead, any profits or losses get passed on to the partners. They’re the ones who need to report their respective slices of the partnership’s income or losses on their individual tax returns.

For example, Mr. and Ms. B, who happen to be a father and daughter, run a joint venture called Cactus Growers. They’re both actively involved in the business and have an equal share of the profits. So, this partnership must fill out Form 1065 to declare its annual income and losses. But they also need to hand out a Schedule K-1 to each partner. In 2022, Cactus Growers raked in $180,000 of net ordinary income. Since Mr. and Ms. B split everything equally, they’ll each report $90,000 of self-employment partnership income on their personal tax returns.

This partnership income goes on page two of Schedule E, the one that deals with additional income and losses from rentals, royalties, partnerships, and such.

Now, partnerships come in different flavors. The default style is a general partnership, where each partner is on the hook for debts and obligations. But there’s also the limited partnership, which has at least one limited partner and a general partner. The limited partner isn’t on the hook for the business’s debts beyond their investment. They can’t sign the partnership return or deal with the IRS as a limited partner in most cases, and they’re often limited in how they can manage the partnership.

For instance, let’s say Carter wants to start a dance club. He turns to his Aunt Mary for cash, and she’s willing to invest but doesn’t want to be part of the day-to-day hustle. So, they set up an unlimited partnership as per their partnership agreement. Mary is a limited partner, investing half a million dollars, while Carter, being the nightclub pro, is the general partner.

The structure of a partnership can vary widely. It might be a small business run by a married couple, or it could be a big, intricate organization with many general and limited partners as investors. There’s no set limit to how many partners a partnership can have, and it can include partners from overseas or be an unincorporated entity. If it’s got two or more partners who are in the business together and splitting the profits, it’s considered a partnership for federal tax purposes.

However, just sharing expenses doesn’t necessarily make a partnership. The IRS says that substantial services are what are effective. These services are usually for the convenience of tenants, like regular cleaning, linen changes, or housekeeper service. In such cases, it’s not considered a partnership with passive rental income reported on Schedule E, but rather something that would go on Schedule C or, if there are multiple partners involved, they’d have to sort it out among themselves.

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