Partnerships
A Partnership is a legal entity where two (or more) people run a business. It is the simplest structure for operating a business with multiple owners. The owners (“partners”) of a Partnership share legal, financial, and management responsibilities for the company.
Highlights of utilizing a Partnerships:
- There is no limit to the number of partners a GP may have.
- Owners of a General Partnership are not considered employees of the company.
- Similar to a Sole Proprietorship, a Partnership is considered to be the same legal and tax-paying entity as its owners.
- All partners are personally liable for the legal and financial debts of the business. So, if a Partnership runs into legal or money troubles, the owners’ personal assets are at risk of being taken to settle those obligations.
- Owners typically get paid by taking owner draws (withdrawing funds out of their business for personal use).
- Partnerships are “pass-through” entities for income tax purposes. Business profits and losses flow through to the partners’ personal tax returns. All of the profits are also subject to self-employment taxes (Medicare and Social Security) because partners are not on the company payroll and do not receive paychecks with Medicare and Social Security taxes deducted from them. Usually, partners must make quarterly estimated tax payments to the IRS, state, and local tax authorities
- Although Partnerships don’t pay tax, they must file an annual information return (Schedule K-1, IRS Form 1065) with the IRS to report the income, deductions, gains, losses, etc. from their operations. Each partner then uses information from that form to report their share of the partnership’s income or loss on their individual tax returns.
Types of Partnerships
General Partnership
A general partnership is the most basic partnership entity and does not require registration with the state. Partners form their business once they sign a formal partnership agreement. In a general partnership, ownership and profits are split equally between the partners unless different terms are outlined in the partnership agreement. In addition, in a general partnership, all partners have equal power to secure contracts and financing. Likewise, each partner also has equal liability and is responsible for the business’s debts and legal obligations. General partnerships are typically simple to form and dissolve. There is no limit to the number of partners a general partnership may have. Owners of a general partnership are not considered employees of the company. They typically get paid by taking owner draws (withdrawing funds from their business for personal use).
Limited Partnership (LP)
Limited partnerships are formal business entities governed by the state. Limited partnerships typically are formed by partners who want investors to help fund their companies but wish to avoid the expense and compliance requirements involved in creating a corporation or LLC. In a limited partnership, at least one general partner and one or more of the limited partners provide funding but are not actively involved in the business’s operations. The general partner or partners are solely responsible for the operations, management, and liabilities, while the limited partners are not responsible for their debts and liabilities. Limited partners share in the business’s profits but must never lose more money than they’ve invested. Limited partners cannot participate in the business’s operations, or they lose their limited partner status.
Limited Liability Partnership (LLP)
A limited liability partnership is a form of business structure used primarily by professionals like attorneys, accountants, physicians, engineers, dentists, and architects. A business must have at least two partners to form a limited liability partnership, and usually, the partners must be licensed in the same profession. The limited liability partnership gives all partners the responsibilities of general partners, but all partners have limited personal liability for the business’s debts. Not all states allow the formation of limited liability partnerships, and some states limit the structure to specific industries. In California, Nevada, New York, and Oregon, professionals must form an LLP by registering as a Professional Limited Liability Partnership (PLLP). The limited liability partnership combines the benefits of a partnership and a corporation and provides liability protection, management flexibility, and potential tax advantages. The amount of personal liability protection that partners receive in an LLP varies from state to state.
Limited Liability Limited Partnership (LLLP)
A newer type of partnership, the limited liability limited partnership (LLLP) is a hybrid of partnership entities and most often is found in the real estate industry. A traditional limited partnership requires the general partner (or general partners) to be personally responsible for the business. The LLLP allows the general partners to have limited risk. This type of entity is popular for investor groups building large projects such as hotels, commercial buildings, or apartment communities. LLLPs are currently only authorized in about half the states in the country.
Advantages and Disadvantages of Partnerships
- Easy to start, since there is no need to register your business with the state.
- No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
- You don’t need to absorb all the business losses on your own because the partners divide the profits and losses.
- U.S. citizens, LLCs, corporations, and foreign individuals or entities may form a General Partnership by agreeing to do business in the U.S. with another party.
- Owners can deduct most business losses on their personal tax returns.
- Each owner is personally liable for the business’s debts and other liabilities. In fact, the actions of one partner could impose liability on the personal assets of another partner.
- In some states, each partner may be personally liable for another partner’s negligent actions or behavior (known as “joint and several liability”).
- Disputes among partners can unravel the business, though drafting a detailed Partnership Agreement can help you avoid this.
- It’s more challenging to get a business loan, land a big client, and build business credit without a registered business entity.
Starting a Partnership
A Partnership is not a formal business entity like a Limited Liability Company or C Corporation. Usually, there is no business registration paperwork required by the state when entrepreneurs want to establish a GP. As soon as the owners begin to conduct business together, the partnership is established.
Creating the Partnership Agreement is the most important step. It will lay out the relationship between the parties.
Some things included in a basic Partnership Agreement:
- Business Name – More important here than in a sole proprietorship because partners will often share business accounts and act in the name of the business.
- Contributions – Each partner’s stake in the formation and ongoing finances of the business must be clearly laid out. How much will each put into the pot? What about future obligations?
- Distributions – How will profits be split between partners? Who gets paid first and how much?
- Ownership – Who gets what if the business is sold? What happens if one partner wants to withdraw? What about taking on new partners? What are the options for buying out another partner?
- Decision Making – Who gets the last say? What about day-to-day management decisions?
- Managing Disputes – How will disputes be handled? Is binding arbitration a good option or will things have to go to court? Does a ‘silent partner’ have a say in business operations?
- Critical Changes and Developments – What happens if one partner gets sick or dies? How will the business be evaluated (and what is the split) if a buy-out offer comes in? What provisions will be used for retirement? Under what circumstances can the partnership agreement be modified, and how?
These are the most common issues. You should see immediately one of the downsides of a Partnership – a substantial difference of opinion between partners. What starts out as a wonderful relationship can change into a phenomenal burden over time and under the stress of doing business.
The best recommendation is to get help when drawing up a Partnership Agreement. Make sure each party fully understands the conditions and the document include as much detail as possible. It is a wise practice to consult an attorney to ‘vet’ the agreement and point out weaknesses.
When a DBA is Needed
When a General Partnership’s owners do not want to include all of the partners’ last names in the business name, they must request to use a tradename. To do so, they need to file a DBA (“doing business as,” also known as a “fictitious name” filing). The DBA must be filed with the state or the county clerk—depending on the business’s location.
For example, if Janice Smith and James Jones want to market their new business by the name “Texas Taco Shack,” they would need to file a DBA for that name with the state or county clerk’s office. Many states also require that businesses have their fictitious name published in one or more approved newspapers or other publications in the county where it was filed.
Fictitious names may need to be renewed, so it’s important to verify the county and state requirements.
Keep in mind that registering a DBA does not provide any legal protection for the company name. Its purpose is to disclose the individual, people, or entity operating the company under the assumed name to the public. This helps protect potential customers, vendors, and others from doing business with unscrupulous owners attempting to hide their real identities. If a Partnership wants to obtain exclusive rights to use its DBA, it must register it as a trademark through the USPTO (U.S. Patent and Trademark Office).
