Partnership terminations triggered by a change in form.

• Author: Owen, Sheila

A partnership terminates under Sec. 708(b)(1) when the business of the partnership is no longer carried on in partnership form. This can occur because the partnership elects out of partnership status, incorporates, or has only one partner remaining (for example, as the result of a sale or the death of a partner). Note that a partnership will also terminate if no part of any of its business, financial operations, or ventures continues to be carried on.

Electing out of partnership status

The partnership form no longer exists (for most purposes) if the partners elect not to be treated as a partnership. The Code permits limited classes of partnerships to elect out of taxation under the partnership rules (or out of selected portions of the partnership rules). The election out of partnership status is available only if the income of the partners can be adequately determined without computing the partnership's income and the arrangement is (1) an investing partnership, (2) an operating agreement, or (3) a securities syndicate (Sec. 761(a); Regs. Sec. 1.761-2).

Termination when only one partner remains

The partnership form also ceases to exist if a transfer of partnership interests occurs and only one partner remains. For example, a partnership terminates when a 60% partner acquires the interests of two other partners who each have a 20% interest in the partnership (Regs. Sec. 1.708-1(b)(1)). The partnership is terminated as of the sale date of the partnership interests. (However, a special rule applies upon the death of a partner in a two-person partnership. See the discussion below.) After the sale of the interests, the business is no longer carried on in a partnership form but rather is conducted as a proprietorship or branch (if the owner is a corporation, another partnership, or a multimember limited liability company (LLC)). A business can also cease to be a partnership if its assets are transferred to a trust or the business is incorporated.

Termination of two-partner partnership at one partner's death or retirement

Two-person partnerships necessitate careful planning to avoid inadvertent terminations. For example, a partnership will terminate if a buy-sell agreement is triggered upon the death of either partner. While such a buy-sell agreement may be appropriate for transfer of the partnership interest and income tax planning, the partners may not intend that the sale result in the termination of the partnership with its potentially adverse...