Partnership & Partner Elections for Federal Tax Purposes

Instructor: Salomien de klerk

Salomien is a Chartered Accountant (South Africa) and has a degree in Accounting and Auditing. She has worked in public practice for 25 years and was also responsible for training staff and clients.

In this lesson, we will briefly discuss income tax elections available to a partnership and define and describe elections that the partners of a partnership are allowed to make individually. Updated: 04/11/2021

The Taxation of a Partnership

A partnership is an enterprise form in which two or more persons join to operate a business, with each person contributing money, property, labor, or skill, and the partners sharing in the profits and losses of the business. A partnership is not a taxpayer in its own right, but rather acts as a flow-through entity that passes on each partner's share of its revenue, deductions, gains on losses to the relevant partner, who then includes it in their personal income tax returns.

To calculate the amount to flow through to each partner accurately, the partnership must keep its proper accounting records and is required to file an information return on Form 1065 with the Internal Revenue Service. This return includes information about the partnership's business and other income. To calculate the items on Form 1065 the partnership must apply various income tax provisions.

Partnership Elections for Federal Tax Purposes

Most of the elections that the Internal Revenue Service allows taxpayers to make must be made on a partnership level. This means that partners cannot, for example, decide to use different taxable year ends for calculating their share of the partnership income, but rather the partnership must elect a tax-year (using the guidelines issued by the IRS) and the partners must comply with that.

On the formation of the partnership, it elects:

  • The tax year of the partnership
  • The accounting basis of the partnership
  • The treatment of organizational and startup expenditures

The partnership, and not each partner, also make various elections that are used to calculate the ordinary business revenue and separately stated items that flow through to the partners. These include:

  • The partnership's depreciation method and the related estimates (like the useful lives and residual values of assets).
  • Section 179 deductions for certain tangible personal property.
  • Cost or percentage depletion method for natural resources, except for oil and gas wells.
  • The inventory method the partnership uses, for example, FIFO, LIFO, or weighted average cost.
  • Treatment of research and experimental expenditures.
  • Optional basis adjustment election allowed by section 754 of the revenue code. This basis adjustment applies when a partner sells his/her interest either to another person or the partnership and the fair market values of the underlying assets differ from the tax basis in the partnership.

Partner Elections for Federal Tax Purposes

Section 703 of the Internal Revenue Code allows for three instances where each partner can individually decide on how they wish to treat an item for income tax purposes. These are:

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