It is sometimes difficult to determine whether an arrangement should be considered a partnership for U.S. tax purposes. Last week in a non-international related Chief Counsel Advice (CCA), the I.R.S. published a good summary of the definition of a partnership under U.S. tax principles. The following is an excerpt from the CCA:
Whether a partnership exists for federal tax purposes is a matter of federal, not state, law. Comm’r v. Tower, 327 U.S. 280, 287-288 (1946). An entity’s status under local law is not determinative for federal tax purposes. Luna v. Comm’r, 42 T.C. 1067, 1077 (1964). The Internal Revenue Code supersedes local law and prescribes its own standards for determining whether a partnership exists. Id.
Treas. Reg. §301.7701-1(a)(1) provides that the Internal Revenue Code prescribes the classification of various organizations for federal tax purposes and that, whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.
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I.R.C. 761(a) provides that the term “partnership” includes a syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation, trust, or estate.
As a threshold matter, an entity separate from its owner must exist before the Service will recognize an arrangement as a partnership for federal tax purposes. Treas. Reg. §301.7701-1(a)(2) provides that a joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom. * * *
Treas. Reg. §301.7701-2(a) provides that a business entity is any entity recognized for federal tax purposes that is not properly classified as a trust. Treas. Reg. §301.7701-2(c) provides that for federal tax purposes, the term partnership means a business entity that is not a corporation under Treas. Reg. §301.7701-2(b) and that has at least two members. * * *
A partnership exists for federal tax purposes when one or more persons join together to carry on a trade or business and share in the profits and losses of that trade or business. Tower, 327 U.S. at 286. The primary inquiry is whether, considering all of the facts, the parties in good faith and acting with a business purpose intended to join together in the present conduct of a business enterprise. Comm’r v. Culbertson, 337 U.S. 733, 742 (1949). The following factors, none of which is conclusive, provide evidence of the parties’ intent: (1) the agreement of the parties and their conduct in executing its terms; (2) the contributions, if any, which each party has made to the venture; (3) the parties’ control over income and capital and the right of each to make withdrawals; (4) whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income; (5) whether business was conducted in the joint names of the parties; whether the parties filed federal partnership returns or otherwise represented to respondent or persons with whom they dealt that they were joint venturers; (6) whether separate books of account were maintained for the venture; and (7) whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise. Luna, 42 T.C. at 1077, 1078. (Emphasis added.)