A partnership is two or more people carrying on a business together for profit. In the US, multi-member LLCs are taxed as partnerships by default, which makes partnership tax rules relevant to far more businesses than the "partnership" label suggests.
Types of partnership
| Type | Liability | Common use |
|---|---|---|
| General partnership (GP) | Unlimited for all partners | Informal co-founder arrangements |
| Limited partnership (LP) | General partner unlimited; limited partners limited | Investment funds, real estate |
| Limited liability partnership (LLP) | Limited for all partners in most states | Law, accounting and professional firms |
| Multi-member LLC | Limited for all members | Most small businesses with co-owners |
How partnerships are taxed
- The partnership files Form 1065 and issues a Schedule K-1 to each partner.
- Each partner pays tax on their distributive share of income whether or not cash is distributed.
- General partners and active LLC members pay self-employment tax (15.3%) on their share of ordinary business income.
- Distributions of previously taxed income are generally tax-free up to the partner's basis.
Example
Two equal partners run a consulting firm with $300,000 of net profit. Partner A receives a $60,000 guaranteed payment for running operations.
| Item | Partner A | Partner B |
|---|---|---|
| Guaranteed payment | $60,000 | $0 |
| Share of remaining $240,000 | $120,000 | $120,000 |
| Total taxable income from the partnership | $180,000 | $120,000 |
| Subject to SE tax | Yes | Yes |
Special allocations
Partnerships can allocate income, losses and deductions differently from ownership percentages, provided the allocations have "substantial economic effect" under Section 704(b). This flexibility is why real estate and investment funds favor partnerships.
The 20% QBI deduction
Partners can claim the Section 199A deduction on their share of qualified business income. It is permanent from 2026. Guaranteed payments are not QBI, and specified service businesses such as law, accounting and consulting lose the deduction above the income thresholds.
State taxes on partnerships
- Pass-through entity taxes: Over 35 states let partnerships pay state tax at the entity level, which remains fully deductible federally while individuals face a $40,000 SALT cap (2025 to 2029).
- Entity-level taxes: Texas franchise tax applies to most partnerships with limited liability; Tennessee applies franchise and excise taxes to LLPs and LPs; New York City levies an Unincorporated Business Tax of 4%.
- Composite returns and withholding: Many states require partnerships to withhold tax for nonresident partners.
BBA audit regime
Since 2018, the IRS audits partnerships at the entity level and can assess tax on the partnership itself unless it elects to push adjustments out to partners. Every partnership must designate a partnership representative.
Partnerships outside the US
- UK: Partnerships and LLPs are transparent; partners pay income tax and Class 4 National Insurance.
- Germany: Partnerships (GbR, OHG, KG) are transparent for income tax but pay trade tax at the entity level, and can opt into corporate taxation.
- Canada: Partnerships are transparent; partners report their share on T1 or T2 returns.
Related: LLC taxes, Corporation taxes, Sole proprietor taxes.
Frequently Asked Questions
Does a partnership pay income tax?
Generally no. A partnership files an informational return (Form 1065) and each partner reports their share of income, deductions and credits from Schedule K-1 on their own return. Some states and cities tax partnerships directly, and many states let partnerships elect to pay a pass-through entity tax.
What is a guaranteed payment?
A guaranteed payment is a fixed amount paid to a partner for services or capital regardless of partnership profit. It is deductible to the partnership and taxable to the partner as ordinary income subject to self-employment tax.
Do limited partners pay self-employment tax?
Limited partners generally do not pay self-employment tax on their distributive share, only on guaranteed payments for services. Recent Tax Court decisions have narrowed this exception for limited partners who are active in the business.
When is the partnership return due?
Form 1065 is due on the 15th day of the third month after year-end, which is March 15 for calendar-year partnerships. A six-month extension is available.