Construction projects can be structured as joint ventures, that then are generally considered partnerships under IRC sections 761(a) and 7701(a)(2). Joint ventures are generally formed for one specific purpose
(a job, a contract, or a project) with the intent of operating for a limited duration.
IRC §7701(a)(2) PARTNERSHIP AND PARTNER.—The term “partnership” includes
a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term “partner” includes a member in such a
syndicate, group, pool, joint venture, or organization.
Such construction projects may also be formed as corporations or, under state law, as some other type of entity. Regardless of the form of the entity under state law, federal tax law applies to classify the entity for federal tax purposes.
The IRS and Treasury have published regulations for classifying business
arrangements for federal tax purposes. These regulations became effective January 1, 1997. When classifying a business arrangement, first determine if there is a separate entity for federal tax purposes. A joint venture may create a separate entity for federal tax purposes if the participants (1) carry on a trade, business, financial operation, or venture and (2) divide the profits from the activity. Nonetheless, a joint undertaking merely to share expenses does not create a separate entity for federal tax purposes. Whether a joint venture is a separate entity for federal tax purposes is a question of federal law. See Treas. Reg. § 301.7701-1.
Treas. Reg. §301.7701-1. (a) Organizations for federal tax purposes— (1) In general. The Internal Revenue Code prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.
(2) Certain joint undertakings give rise to entities for federal tax purposes. A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom. For example, a
separate entity exists for federal tax purposes if co-owners of an apartment building lease space and in addition provide services to the occupants either directly or through an agent. Nevertheless, a joint undertaking merely to share expenses does not create a separate entity for federal tax purposes. For example, if two or more persons jointly construct a ditch merely to drain surface water from their properties, they have not created a separate entity for federal tax purposes. Similarly, mere co-ownership of property that is maintained, kept in repair, and rented or leased does not constitute a
separate entity for federal tax purposes. For example, if an individual owner, or tenants in common, of farm property lease it to a farmer for a cash rental or a share of the crops, they do not necessarily create a separate entity for federal tax purposes.
A separate entity conducting construction operations will generally be treated as a business entity under the new regulations. A business entity with two or more members is classified either (1) as an association taxable as a corporation or (2) as a partnership. Except for certain business entities that are defined as corporations, a business entity may elect to be treated as either an association or a partnership (an eligible entity). See Treas. Reg. section 301.7701-2.
Treas. Reg. §301.7701-2(a) Business entities. For purposes of this section and §301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity
separate from its owner under §301.7701-3) that is not properly classified as a trust under §301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.
The regulations provide default rules that classify eligible entities without requiring them to file elections. Unless it elects otherwise, a domestic eligible entity that is formed after January 1, 1997, is classified as a partnership, if it has at least two members. Unless it elects otherwise, a foreign eligible entity that is formed after January 1, 1997, is
classified as either (1) a partnership, if it has at least two members and at least one member does not have limited liability, or (2) an association, if all members have limited liability. Generally, an eligible entity in existence prior to January 1, 1997, maintains the classification it claimed under the classification regulations in effect prior to January 1, 1997. An eligible entity may elect to be classified other than as provided in the default rules or to change its classification by filing a Form 8832, Entity Classification Election, with the appropriate service center. See Treas. Reg. section 301.7701-3.
For financial statement purposes, investments in joint ventures are accounted for by each member of the joint venture under the cost method, the equity method, as a pro rata share, or the entity is consolidated with the investor's financial statements. For financial accounting purposes, the accounting method used to account for the construction company's investment in a joint venture, is based on the ownership percentage and the degree of control the construction company has over the venture. Inspection of the taxpayer's consolidated financial statements can provide the auditor with an extended view of the construction company's investment in joint ventures, because both incorporated projects and joint ventures are often consolidated. In
addition, financial information of unconsolidated joint ventures is frequently disclosed in the notes to the financial statements.
Joint ventures classified as partnerships are generally required to file separate income tax returns (Form 1065). Individual partners or investors recognize a distributive share of partnership items (reported on Schedule K-1) from the construction joint venture on their income tax returns. Partnerships are formed as general partnerships or limited partnerships. A general partnership is an association where all partners have unlimited liability. A limited partnership is an association in which one or more general partners have unlimited liability, while one or more limited partners have limited liability.