What Is Revenue Code 761 and How Does It Work?

Internal Revenue Code Section 761 provides the definition of a “partnership” for federal tax purposes. This definition is broad, capturing many informal business and investment arrangements. The code also establishes a method for certain qualifying organizations to elect out of this partnership tax treatment, allowing members to report their income and deductions individually.

Defining a Partnership Under the Code

A partnership includes any syndicate, group, pool, joint venture, or other unincorporated organization used to carry on any business, financial operation, or venture. This definition applies even if the arrangement is not a formal partnership under state law. The primary factor is the collaboration of two or more persons in a venture with the aim of joint profit.

This broad scope means many informal agreements can be classified as partnerships by default for tax purposes. For instance, two individuals co-owning a rental property and sharing income and expenses could be a partnership. This classification requires filing Form 1065, U.S. Return of Partnership Income, and issuing Schedule K-1s to each partner.

Eligibility to Elect Out of Partnership Treatment

The tax code allows certain organizations to be excluded from partnership tax rules. To be eligible, the organization must be an unincorporated entity used for specific purposes. One category includes organizations for investment purposes only, not for the active conduct of a business. This often applies to co-ownership arrangements where participants jointly hold investment property but do not actively manage it as a business.

Another qualifying category is for organizations involved in the joint production, extraction, or use of property, but not for selling the property or services. A condition for any eligible organization is that the members’ incomes can be determined without calculating a separate partnership taxable income. This means the financial arrangement must be simple enough for each member to compute their share of income and expenses from their own records. All members of the organization must agree to make the election.

Making the Election

An organization that meets the eligibility requirements can elect out of partnership treatment. This is not an automatic process and requires a specific action. The election is made by attaching a statement to the partnership’s tax return, Form 1065, for the first taxable year the election is to be effective. Even though the goal is to avoid filing this return in the future, it is used as the vehicle for the initial election.

The statement must include the name and address of the organization and all its members. It needs to affirm that the organization qualifies for the election, that all members have elected to be excluded from partnership tax rules, and it must indicate where a copy of the operating agreement is located. Once a valid election is made, the organization does not need to file a partnership return for subsequent years.