A partnership is a business arrangement whereby the partners share in the capital and services provided, plus they share the profits that result from their partnership. According to the IRS, "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." A partnership where all the partners do is invest money and then expect profits to come out isnt really a partnership. In the eyes of the IRS, you not only have to invest the money, but also perform the services that you are offering through this partnership.
The rules governing the creation of a partnership changed in 1996. Any partnerships before 1997 dont have to adhere to these changes only if they have at least two partners and they dont elect to fill out the form 8832 to become a corporation.
There are some organizations that cant become partnerships according to the IRS. They are the following:
A partnership agreement that is simple to follow and understand should be established by every organization with two or more partners and it should include the original agreement and any modifications that have been made. The IRS asks that all partners must agree to all modifications and adopt them in any other manner provided by the partnership agreement. The agreement or modifications can be oral or written.
The rules for partnerships among family member (spouses, ancestors, and lineal descendants [or a trust for the primary benefit of those persons]) are a little different. They have to meet one of the following two conditions as outlined by Uncle Sam:
A good example to consider for the first condition is a grocery store. Joe, the owner of the store, decides to give his son Mike 50% of the business. The profit from the business is $50,000. Joe is the one who performs the services, and they are estimated to be around $20,000. Mike doesnt perform any services. Come tax time, the IRS is only going to look at $30,000 worth of profits. The services performed by Joe cut into the profit and the leave the remaining partnership profit at $30,000. The money is split right down the middle and Mike ends up with $15,000. Because he didnt share the services, they went 100% to his father.
Husband/wife partnerships also have their own rules. Husband/wife partnerships can survive without partnership agreements as long as they have an understanding about the profits and losses. Each spouse has to file a form 1065, not a schedule C for form 1040. Each has to carry over their share of the profits and the losses to the form 1065 and attach to there joint or separate form 1040. They also have to file a separate form for self-employment taxes if they are self-employed, schedule SE with form 1040.