Forming a Partnership for Tax Purposes
A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:
- is not registered as anything under state law,
- is a partnership, limited partnership, or limited liability partnership, or
- is a limited liability company.
Publicly traded businesses cannot elect to be treated as partnerships. They are automatically taxed as corporations.
Form 8832 allows a business to select its classification for tax purposes by checking the box on the form: partnership, corporation, or disregarded. If no check-the-box form is filed, the IRS will assume that the entity should be taxed as a partnership or disregarded as a separate entity. An LLC that makes no federal election will be taxed as a partnership if it has more than one member and disregarded if it has only one member. An LLC must make an affirmative election to be taxed as a corporation. The IRS language on Form 8832 uses the term "association" to describe an LLC taxed as a corporation.
Form 8832 has no particular due date. There is a space on the form (line 4) for the entity to note what date the election should take effect. The date named can be no earlier than 75 days before the form is filed, and no later than 12 months after the form is filed. It is most important to file Form 8832 within the first few months of operations if the entity desires a tax treatment that differs from the tax status the IRS will apply by default if no election is made.
A few businesses do not qualify to be partnerships for federal tax purposes. These are:
- a business that is a corporation under state law,
- a joint stock company (a corporation without limited liability),
- an insurance company,
- most banks,
- an organization owned by a state or local government,
- a tax-exempt organization
- a real estate investment trust, or
- a trust.
Although these businesses cannot be partnerships, they can be partners in a partnership (they can join together to form a partnership).
Of course, whether your business is best operated as a partnership, as a corporation or as another type of entity should not only be driven by short-term tax considerations. How you envision your business will develop over time, whether your business is asset or service intensive, and what personal financial stake you plan to take, among other factors, are all additional factors that should be considered.