A business partnership may be defined as an unincorporated organization with two or more members if its members are engaged in a trade, business, financial operation, or venture and divide its profits. A partnership may not be formed strictly to share expenses, however.

Business partnerships are considered to be “pass-through” entities for the purposes of taxation. Therefore, the profits and losses of the partnership pass through the business to the partners. The IRS does not consider partnerships to be separate from their owners for the purposes of taxes. The partners pay taxes on their share of the profits on their own individual income tax returns. Each partner's share of profits and losses is usually agreed on and contracted in a written partnership agreement.

But even though the partnership itself does not pay income taxes, it still must file IRS tax forms. The form it must file is an informational return that the IRS reviews to determine whether the partners are reporting their income correctly. The partnership must also provide a schedule that discloses each partner's share of the business's profits and losses. Each partner will then also report this profit and loss information on their own individual tax returns.

Each partner must pay income taxes on his or her distributive share. The distributive share is the portion of profits to which the partner is entitled under a partnership agreement. If the partners did not make such an agreement, then their portions will be determined by state law. Each partner must pay taxes on his or her share of the partnership’s profits, regardless of how much money was taken from the partnership. Furthermore, even if partners must leave profits in the partnership to cover expenses or expand their business, each partner will still owe tax on his or her portion of the profit. It’s possible for partners to divide their profits and losses in some way other than being proportionate to the partners’ interests in their business. Doing so is called a special allocation, which requires careful adherence to IRS rules.

Because partners do not have an employer to withhold income taxes for them, they each must be diligent to set aside enough money to pay their tax share on the partnership’s annual profits. They need to estimate the amount of tax owed for the year and be prepared to make tax payments on a quarterly basis.