A two-person LLC files its 2025 Form 1065 four months late. No tax is due, yet the bill arrives anyway: two partners, four months, $255 each per month.
A partnership exists when two or more persons join together to carry on a trade or business and share the profits. Partnership formation needs no written document. Even so, the partnership agreement matters a great deal, because it controls almost everything the Internal Revenue Code (the Code) lets the partners decide for themselves.
The partnership agreement governs these items:
- How profits and losses are shared (the sharing ratios). This includes special allocations, which must carry substantial economic effect under §704(b).
- Guaranteed payments to partners for their services or for the use of their capital, under §707(c).
- How new partners are admitted, the terms for buying a partner out, and what happens on the death of a partner.
- Whether the partners are general or limited partners, and who manages the business.
KEY: The partnership agreement includes any change the partners adopt up to the unextended due date of the return (the original due date, ignoring any extension).
Common mistakes
- Applying §351's control test to §721. Candidates deny nonrecognition on a small contribution because the contributor lacks 80 percent control. That test comes from §351, which covers corporations. There is no control threshold for partnership formation.
- Excluding COD at the partnership level. Some candidates apply the insolvency test to the partnership's balance sheet instead of each partner's. That is the wrong balance sheet: a partnership can be insolvent while every partner is solvent and fully taxable on the allocated COD.
- Computing the §6698 penalty per return. The penalty is per partner per month, so it grows with every partner. A 10-partner partnership three months late owes $255 × 10 × 3 = $7,650, not $765.
Bottom line
- Section 721 gives nonrecognition on capital contributions with no control requirement; outside basis is carryover basis plus liability share minus debt relief, floored at zero.
- General partners carry unlimited liability and self-employment tax on distributive share; limited partners generally escape self-employment tax but not on guaranteed payments.
- Form 1065 is due March 15, 2026 for calendar-year 2025, extendable six months to September 15, 2026; §7503 moves a weekend or holiday date to the next business day.
- Section 6698 charges per partner per month up to 12 months and applies with zero tax due: $245 per partner per month for returns filed in 2025; $255 for returns filed in 2026.
Exam shortcut
Read the stem for the level first. If the fact pattern names an insolvent partner, the answer is partner-level: exclude only up to that partner's insolvency, and never touch the other partners' income. For any penalty computation, find three numbers before you calculate: partner count, months late (round any fraction up to a full month), and whether tax was due. The last one is a decoy.
The full lesson (about 4,146 words, 28 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 2
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