Partnership Taxation Explained: How the IRS Taxes Partnerships

General vs. Limited Partnerships

In tax and legal terms, partnerships come in two main forms. General Partnerships (GP) involve partners who manage the business and share unlimited personal liability for its debts. Limited Partnerships (LP) have at least one general partner who manages operations and limited partners who invest capital but do not participate in management and have liability limited to their investment.

How Partnerships Are Taxed

Partnerships are pass-through entities — the partnership itself does not pay income tax. Instead, it files Form 1065 (an information return) and issues Schedule K-1 to each partner showing their share of income, deductions, credits, and losses. Each partner reports their K-1 amounts on their personal tax return.

This pass-through treatment means partners pay tax on their share of partnership income regardless of whether they received cash distributions. A partner allocated $50,000 of income but receiving no distributions still owes tax on that $50,000.

Self-Employment Tax Considerations

General partners' distributive share of partnership income is generally subject to self-employment tax (Social Security and Medicare). Limited partners are typically only subject to self-employment tax on guaranteed payments for services, not on their distributive share of partnership income. This distinction makes LP structures attractive for certain types of investments.