Form 541 - Partnerships - Department Of Treasury Internal Revenue Service

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The business entity is not treated as a

Partners can modify the partnership agree-

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The owner withdraws from the partner-

corporation.

ment for a particular tax year after the close of

ship.

the year but not later than the date for filing the

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For more information about community prop-

The partnership liquidates.

partnership return for that year. This filing date

erty, see Publication 555, Community Property.

does not include any extension of time.

Publication 555 discusses the community prop-

The mere right to share in earnings and profits

If the partnership agreement or any modifica-

erty laws of Arizona, California, Idaho, Louisi-

is not a capital interest in the partnership.

tion is silent on any matter, the provisions of

ana, Nevada, New Mexico, Texas, Washington,

local law are treated as part of the agreement.

and Wisconsin.

Gift of capital interest. If a family member (or

any other person) receives a gift of a capital

Limited liability company. A limited liabil-

interest in a partnership in which capital is a

ity company (LLC) is an entity formed under

Terminating a

material income-producing factor, the donee’s

state law by filing articles of organization as an

distributive share of partnership income is sub-

LLC. Unlike a partnership, none of the members

Partnership

ject to both of the following restrictions.

of an LLC are personally liable for its debts. An

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LLC may be classified for federal income tax

It must be figured by reducing the partner-

A partnership terminates when one of the follow-

purposes as either a partnership, a corporation,

ship income by reasonable compensation

ing events takes place.

or an entity disregarded as an entity separate

for services the donor renders to the part-

from its owner by applying the rules in regula-

nership.

1) All its operations are discontinued and no

tions section 301.7701 – 3. See Form 8832 for

part of any business, financial operation,

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The donee’s distributive share of partner-

more details.

or venture is continued by any of its part-

ship income attributable to donated capital

ners in a partnership.

A domestic LLC with at least two mem-

must not be proportionately greater than

TIP

bers that does not file Form 8832 is

the donor’s distributive share attributable

2) At least 50% of the total interest in partner-

classified as a partnership for federal

ship capital and profits is sold or ex-

to the donor’s capital.

income tax purposes.

changed within a 12-month period,

Purchase. For purposes of determining a

including a sale or exchange to another

partner’s distributive share, an interest pur-

partner.

chased by one family member from another

Organizations formed before 1997. An or-

See section 1.708 – 1(b) of the regulations

family member is considered a gift from the

ganization formed before 1997 and classified as

for more information on the termination of a

seller. The fair market value of the purchased

a partnership under the old rules will generally

partnership. For special rules that apply to a

interest is considered donated capital. For this

continue to be classified as a partnership as long

merger, consolidation, or division of a partner-

purpose, members of a family include only

as the organization has at least two members

ship, see sections 1.708 – 1(c) and 1.708 – 1(d)

spouses, ancestors, and lineal descendants (or

and does not elect to be classified as a corpora-

of the regulations.

tion by filing Form 8832.

a trust for the primary benefit of those persons).

Date of termination. The partnership’s tax

Family Partnership

Example. A father sold 50% of his business

year ends on the date of termination. For the

to his son. The resulting partnership had a profit

event described in (1), earlier, the date of termi-

of $60,000. Capital is a material income-produc-

Members of a family can be partners. However,

nation is the date the partnership completes the

ing factor. The father performed services worth

family members (or any other person) will be

winding up of its affairs. For the event described

$24,000, which is reasonable compensation,

recognized as partners only if one of the follow-

in (2), earlier, the date of termination is the date

and the son performed no services. The

ing requirements is met.

of the sale or exchange of a partnership interest

$24,000 must be allocated to the father as com-

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that, by itself or together with other sales or

If capital is a material income-producing

pensation. Of the remaining $36,000 of profit

exchanges in the preceding 12 months, trans-

factor, they acquired their capital interest

due to capital, at least 50%, or $18,000, must be

fers an interest of 50% or more in both capital

in a bona fide transaction (even if by gift or

allocated to the father since he owns a 50%

and profits.

purchase from another family member),

capital interest. The son’s share of partnership

actually own the partnership interest, and

profit cannot be more than $18,000.

Short period return. If a partnership is termi-

actually control the interest.

nated before the end of the tax year, Form 1065

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If capital is not a material income-produc-

Husband-wife partnership. If spouses carry

must be filed for the short period, which is the

ing factor, they joined together in good

on a business together and share in the profits

period from the beginning of the tax year through

faith to conduct a business. They agreed

and losses, they may be partners whether or not

the date of termination. The return is due the

that contributions of each entitle them to a

they have a formal partnership agreement. If so,

15th day of the fourth month following the date of

share in the profits, and some capital or

they should report income or loss from the busi-

termination. See Partnership Return (Form

service has been (or is) provided by each

ness on Form 1065. They should not report the

1065), later, for information about filing Form

partner.

income on a Schedule C (Form 1040) in the

1065.

name of one spouse as a sole proprietor.

Each spouse should carry his or her share of

Conversion of partnership into limited liabil-

Capital is material. Capital is a material

the partnership income or loss from Schedule

ity company (LLC). The conversion of a part-

income-producing factor if a substantial part of

K – 1 (Form 1065) to their joint or separate

nership into an LLC classified as a partnership

the gross income of the business comes from

Form(s) 1040. Each spouse should include his

for federal tax purposes does not terminate the

the use of capital. Capital is ordinarily an

or her respective share of self-employment in-

partnership. The conversion is not a sale, ex-

income-producing factor if the operation of the

come on a separate Schedule SE (Form 1040),

change, or liquidation of any partnership inter-

business requires substantial inventories or in-

Self-Employment Tax. This generally does not

est, the partnership’s tax year does not close,

vestments in plants, machinery, or equipment.

increase the total tax on the return, but it does

and the LLC can continue to use the

give each spouse credit for social security earn-

partnership’s taxpayer identification number.

Capital is not material. In general, capital is

ings on which retirement benefits are based.

not a material income-producing factor if the

However, the conversion may change some

of the partners’ bases in their partnership inter-

income of the business consists principally of

Partnership Agreement

ests if the partnership has recourse liabilities

fees, commissions, or other compensation for

that become nonrecourse liabilities. Because

personal services performed by members or

The partnership agreement includes the original

the partners share recourse and nonrecourse

employees of the partnership.

agreement and any modifications. The modifica-

liabilities differently, their bases must be ad-

tions must be agreed to by all partners or

Capital interest. A capital interest in a part-

justed to reflect the new sharing ratios. If a

adopted in any other manner provided by the

nership is an interest in its assets that is distrib-

decrease in a partner’s share of liabilities ex-

utable to the owner of the interest in either of the

partnership agreement. The agreement or modi-

ceeds the partner’s basis, he or she must recog-

following situations.

fications can be oral or written.

nize gain on the excess. For more information,

Page 3

Form 541 - Partnerships - Department Of Treasury Internal Revenue Service - 2002 Page 3

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