Under U.S. tax law, taxation of partnerships is governed by Subchapter K of the Internal Revenue Code, and this particular field of tax is widely understood as the most sophisticated area of taxation regimes in the United States. Much of the sophisticated (and potentially counter-intuitive) methods found in Subchapter K stem from two competing approaches to how we view the partnership. These two approaches are the “Aggregate Approach” and the “Entity Approach”. By getting to know the theory behind these two approaches, we can better comprehend the avenue of logic by which many of the provisions of Subchapter K are written, even as they may seem to conflict with one another. The purpose of this article is to describe these two approaches.1
The aggregate approach to partnerships views the partnership as simply a reference to several partners acting as co-owners of a single business interest. Under this approach, each partner is fully accountable for their share of the business’ operations, and the business itself exists only to be a vehicle for two or more owners to operate under a single business entity. This approach is the reasoning behind how partnerships are taxed in the United States: although the operations of the partnership are stated as a single partnership entity on a Form 1065 that is filed with the IRS, any income tax is only assessed against each partner as they recognize their share of the results of the operations of the partnership.
In contrast, the entity approach to partnerships views the partnership as a separate and distinct entity against which tax liabilities can be assessed and to which each partner has a piece of ownership. With this approach, partnerships begin to feel a lot more like a corporation for tax purposes. While the theory of this approach is not so often used in the context of partnership taxation, it is certainly not absent. For example, partnerships maintain some level of distinction for tax purposes in the sense that each partnership has its own separate reporting period, separate calculation of basis in assets, and separate methods of accounting. Thus, even though the results of a partnerships operations ultimately are divided and distributed to each partner, the aforementioned issues are addressed by the partnership itself and impact the results that are entered on the partnerships Form 1065.
- The full text of Subchapter K of the Internal Revenue Code is available through the Legal Information Institute at https://www.law.cornell.edu/uscode/text/26/subtitle-A/chapter-1/subchapter-K.