General Partnership
A general partnership is an unincorporated business with two or more owners carrying on a trade or business for profit. For REG, the most important point is that a general partnership is usually a pass-through entity for federal income tax purposes, even though it is a separate entity for many accounting and legal purposes.
Core legal and tax profile
- Owners: Two or more general partners.
- Liability: Each general partner generally has unlimited personal liability for partnership obligations.
- Federal return: The partnership files Form 1065, but the entity usually does not pay federal income tax.
- Tax character: Items flow through to partners on Schedule K-1.
Formation and basis rules
Contributions to the partnership
A contribution of cash or property to a partnership is generally nonrecognition to both the partner and the partnership, unless an exception applies.
Outside basis
A partner's outside basis usually begins with:
- Cash contributed
- Adjusted basis of property contributed
- Plus the partner's share of partnership liabilities
- Minus liabilities assumed by the partnership that reduce the partner's economic burden
Inside basis
The partnership's inside basis in contributed property is generally a carryover basis.
These basis rules are heavily tested because they drive the treatment of losses, distributions, and the sale of a partnership interest.
Flow-through taxation
How Form 1065 works
The partnership itself is not a taxpaying entity — it files Form 1065 as an information return to report its income, deductions, gains, losses, and credits. The results are allocated to partners via Schedule K (partnership-level summary) and individual Schedule K-1s (one per partner).
Each partner reports their share of partnership items on their own Form 1040 (or other applicable return) regardless of whether the income was actually distributed.
A partnership must file Form 1065 by the 15th day of the 3rd month after the close of its tax year (March 15 for calendar-year partnerships). This is one month earlier than individual returns. The partnership may request a 6-month extension.
Ordinary business income vs. separately stated items
Partnership income is divided into two categories:
Ordinary business income (loss) includes items that do not need separate treatment — revenue, COGS, operating expenses, depreciation, and similar items. These are netted on page 1 of Form 1065.
Separately stated items must be reported individually because they may be subject to different limitations or treatment at the partner level:
| Category | Examples |
|---|---|
| Capital gains and losses | Short-term and long-term |
| Section 1231 gains and losses | Gains/losses on business property held > 1 year |
| Charitable contributions | Subject to partner-level AGI limitations |
| Interest income | Portfolio and tax-exempt |
| Dividend income | Qualified and nonqualified |
| Rental income and losses | Subject to passive activity rules at partner level |
| Section 179 expense | Subject to partner-level dollar and income limits |
| Foreign taxes paid | Eligible for credit or deduction at partner level |
| Investment interest expense | Subject to investment interest limitation |
| Self-employment earnings | Used for SE tax computation |
Example: BIF Partners (a general partnership with two equal partners, Jamie and Sarah) has $200,000 of ordinary business income, $30,000 of long-term capital gain, and $10,000 of charitable contributions. Each partner's K-1 reports $100,000 of ordinary income, $15,000 of LTCG, and $5,000 of charitable contributions. The charitable contributions are separately stated because each partner's deduction depends on their own AGI.
Guaranteed payments
A guaranteed payment is a payment to a partner for services rendered or for the use of capital, determined without regard to the partnership's income.
Tax treatment
| Aspect | Treatment |
|---|---|
| To the partnership | Deductible as an ordinary business expense (reduces ordinary income) |
| To the receiving partner | Ordinary income — reported on the partner's return |
| Self-employment tax | Subject to SE tax for the receiving partner |
| Timing | Included in the partner's income for the partnership's tax year in which the partnership deducted the payment |
Example: Marcus is a partner in BIF Partners and receives a guaranteed payment of $60,000 for management services. BIF Partners deducts the $60,000 as an expense. Marcus reports $60,000 as ordinary income on his Form 1040, and it is included in his self-employment income — even if BIF Partners had a loss for the year.
:::tip Guaranteed Payments vs. Distributions
Guaranteed payments are for services or use of capital and are deductible by the partnership. Regular distributions are returns of partnership profits/capital, are not deductible, and reduce the partner's outside basis. Know the difference — it is heavily tested.
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Organizational and start-up costs
A partnership may immediately expense up to $5,000 of organizational expenditures, with the remainder amortized over 180 months. The same rule applies separately to start-up costs.
The $5,000 immediate deduction is reduced dollar-for-dollar when total costs exceed $50,000.
| Cost Type | Examples | Treatment |
|---|---|---|
| Organizational | Legal fees for partnership agreement, filing fees, accounting fees for setting up books | Up to $5,000 immediate + 180-month amortization |
| Start-up | Market research, advertising before operations begin, employee training | Up to $5,000 immediate + 180-month amortization |
| Syndication costs | Commissions and fees for selling partnership interests | Never deductible — must be capitalized |
Example: BIF Partners incurs $3,500 in organizational costs and $52,000 in start-up costs. The organizational costs ($3,500) are fully deductible immediately. For start-up costs, the $5,000 immediate deduction is reduced by $2,000 ($52,000 − $50,000), so BIF deducts $3,000 immediately and amortizes the remaining $49,000 over 180 months.
:::caution Syndication Costs
Costs of marketing and selling partnership interests (brokerage fees, printing prospectuses, etc.) are syndication costs — they are capitalized and never deductible or amortizable.
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Qualified Business Income (QBI) deduction
Partners may be eligible for the Section 199A QBI deduction — up to 20% of qualified business income flowing through from the partnership. The deduction is taken at the partner level on Form 1040.
For higher-income taxpayers, the deduction may be limited by:
- W-2 wages paid by the partnership
- Unadjusted basis immediately after acquisition (UBIA) of qualified property
- Whether the business is a specified service trade or business (SSTB)
Example: Jamie's share of BIF Partners' qualified business income is $100,000. If she is under the income threshold, her QBI deduction is 20% × $100,000 = $20,000 — a deduction taken on her personal return.
Partner's tax basis (outside basis)
A partner's outside basis (tax basis in the partnership interest) determines the deductibility of losses, the tax treatment of distributions, and the gain or loss on sale of the interest.
The BASE mnemonic
:::tip BASE — Memorize This
Use the BASE mnemonic to compute a partner's ending outside basis:
| Letter | Component |
|---|---|
| B | Beginning tax basis |
| A | Add: contributions, all income items (ordinary + separately stated + tax-exempt income), and increase in share of partnership liabilities |
| S | Subtract: distributions, all losses and deductions, nondeductible expenses (e.g., 50% of meals, penalties), and decrease in share of partnership liabilities |
| E | Ending tax basis |
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Detailed basis adjustments
| Adjustment | Direction |
|---|---|
| Cash contributions | Increase |
| Property contributions (at adjusted basis) | Increase |
| Partner's share of partnership liabilities | Increase |
| All income items (ordinary + separately stated) | Increase |
| Tax-exempt income (e.g., municipal bond interest) | Increase |
| Cash distributions received | Decrease |
| Property distributions (at adjusted basis to partnership) | Decrease |
| Decrease in share of partnership liabilities | Decrease |
| All loss and deduction items | Decrease |
| Nondeductible, noncapital expenditures | Decrease |
:::info Partnership Liabilities Increase Basis
A critical distinction from S corporations: in a partnership, a partner's share of entity-level liabilities (recourse and nonrecourse) increases outside basis. This means a partner can deduct losses funded by partnership borrowing — something an S corporation shareholder generally cannot do.
::: Example — Outside basis computation:
Sarah contributes $40,000 cash to BIF Partners for a 50% interest. The partnership borrows $100,000 from a bank (recourse). Sarah's share of liabilities is $50,000.
| Item | Amount |
|---|---|
| Cash contribution | $40,000 |
| Share of partnership liabilities (50% × $100,000) | +$50,000 |
| Initial outside basis | $90,000 |
During the year, the partnership earns $60,000 of ordinary income, $10,000 of tax-exempt interest, and distributes $20,000 cash to Sarah.
| Adjustment | Amount |
|---|---|
| Beginning basis | $90,000 |
| + Share of ordinary income (50%) | +$30,000 |
| + Share of tax-exempt income (50%) | +$5,000 |
| − Cash distribution | −$20,000 |
| Ending outside basis | $105,000 |
Tax basis limitation on losses
A partner can deduct passed-through losses only to the extent of their outside basis. Basis cannot go below zero.
Loss suspension and carryforward
| Rule | Detail |
|---|---|
| Limitation | Losses limited to outside basis |
| Suspended losses | Carried forward indefinitely until the partner obtains additional basis |
| Sources of additional basis | Contributions, income allocations, increased share of liabilities |
| Losses on disposal | Suspended losses that have not been utilized are permanently lost when the partner disposes of the partnership interest |
:::warning Losses Lost on Disposal
If a partner sells or abandons a partnership interest while suspended losses remain, those losses are permanently lost — they cannot be deducted on the final return. This makes it critical to plan basis increases before exiting a partnership.
::: Example: Jamie's outside basis in BIF Partners is $15,000. Her share of ordinary losses for the year is $22,000. She can deduct only $15,000 (reducing her basis to zero). The remaining $7,000 is suspended and carries forward. If Jamie sells her interest next year before restoring basis, the $7,000 is lost forever.
Full loss limitation ordering
After the basis limitation, losses must also pass through the at-risk limitation and the passive activity loss limitation before they are deductible:
- Tax basis limitation (outside basis)
- At-risk limitation (Section 465)
- Passive activity limitation (Section 469)
- Excess business loss limitation (Section 461(l))
Self-employment tax
A general partner's distributive share of trade or business income is generally included in self-employment income. This includes both:
- The partner's share of ordinary business income
- Any guaranteed payments received for services
:::note Limited Partners
A limited partner's distributive share is generally not subject to self-employment tax (except for guaranteed payments for services). This distinction is a key planning consideration.
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LLC tax classification
A domestic limited liability company (LLC) with two or more members is classified as a partnership by default under the IRS "check-the-box" regulations — unless it elects to be treated as a corporation.
| Number of Members | Default Classification | Can Elect |
|---|---|---|
| Single member | Disregarded entity (sole proprietorship) | Corporation |
| Two or more members | Partnership | Corporation (C or S) |
An LLC taxed as a partnership follows all the rules discussed above — Form 1065 filing, K-1 distribution, basis rules, guaranteed payments, and SE tax treatment — but LLC members typically enjoy limited liability protection (unlike general partners).
Distributions and liquidation
Nonliquidating distributions
A current distribution is usually tax free to the extent of the partner's outside basis. Gain is generally recognized only if cash distributed exceeds outside basis.
Liquidating distributions
A liquidating distribution ends the partner's interest. Basis must be allocated to the distributed assets, and special rules apply to cash, receivables, and inventory items.
Advantages and disadvantages
| Topic | General Partnership |
|---|---|
| Tax regime | Pass-through taxation |
| Formation | Flexible and easy to organize |
| Liability protection | General partners usually have none |
| Basis flexibility | Liability allocations can increase outside basis |
| Management | Partners can participate directly |
REG quick hits
- Form 1065 is informational, not usually tax-paying — due March 15 for calendar-year partnerships.
- Partners receive Schedule K-1s with their share of all items.
- Track both inside basis and outside basis.
- Use the BASE mnemonic: Beginning + All income − Subtractions (losses, distributions, nondeductible) = Ending basis.
- Partnership liabilities increase outside basis (unlike S corps).
- Losses limited to outside basis — suspended losses carry forward indefinitely but are lost on disposal.
- Guaranteed payments: ordinary income to partner, deductible by partnership, subject to SE tax.
- General partners usually pay self-employment tax on business income.
- Organizational costs: $5,000 immediate + 180-month amortization (reduced dollar-for-dollar above $50,000).
- Syndication costs are never deductible.
- Partners may claim the QBI deduction (up to 20%) at the individual level.
- LLCs with 2+ members default to partnership taxation.
Bottom line
A general partnership combines pass-through taxation with management flexibility, but the tradeoff is unlimited liability for the partners. On the exam, the major themes are basis computation (the BASE mnemonic), liability allocations, separately stated items, guaranteed payments, SE tax, the loss limitation ordering, and the tax treatment of distributions.