Breaking up a business partnership? Sorry to say it, but the IRS doesn’t believe in clean breakups. Even if everyone agrees to walk away like grown-ups, the tax side can still sneak up and bite you.
Here’s what to watch out for before you call it quits.
1. You Might Owe Tax on “Phantom Income”
Just because you’re dissolving the partnership doesn’t mean you’re off the hook for gains.
If the partnership owns appreciated assets (real estate, equipment, customer lists, even inventory) you may be triggering a taxable event when you shut it down.
That means you could owe taxes on paper profits you never actually saw. Fun, right?
2. Debt Gets Real Weird
If the partnership had debt and you’re relieved of your share, that can actually count as income.
Yes, you read that right. Getting out of debt can create more tax.
3. You Still Need to File One Last Return
Even if you’re done doing business, the partnership still needs to file a final Form 1065.
Miss this, and the IRS can slap on penalties, even years after the doors are closed.
4. What You Walk Away With Matters
Distributions during a shutdown can cause capital gains, especially if one partner gets more than their share of appreciated assets.
Everything has to be tracked. Everything gets reported.
If someone walks away with the truck, and the other gets the tools, that needs to be accounted for.
5. Partners May Owe Different Taxes
One partner might owe more than another, depending on basis, distributions, and how losses were previously allocated.
So if your partner says, “Don’t worry. We’re good,” you might not be.
Thinking About Closing a Partnership?
Let’s talk first. A few smart moves now can prevent painful surprises later.
Before you sign anything, sell anything, or shake hands and walk away… let’s look at the numbers together. We’ll keep the exit clean and the IRS out of your rearview mirror.
