If you’re thinking about starting a Partnership, there are some important considerations to keep in mind. As with every business venture, there are advantages and challenges involved with operating a Partnership, and it’s best to understand what you’re getting into before you invest your time and money in a new venture.
In this article, we’ll explore some pros and cons of this type of business structure, steps to keep in mind when setting up a Partnership, different types of Partnerships, and tax information that applies to this type of business entity.
Let’s start by defining exactly what a Partnership is.
What is a Partnership?
A Partnership is simply a business that’s owned by two or more people. Similar to a Sole Proprietorship, a Partnership is not required to be registered with the state, although in some cases, owners do formally file and register their businesses. A business with two or more owners that is not registered with the state is called a General Partnership.
Even though a Partnership doesn’t need to file paperwork with the state, it must obtain any licenses or permits necessary to conduct business. Business licenses can be required at the local, state, and federal levels, so you’ll need to conduct some research to find out what is required.
And if you want to give the business a name that’s different from those of its owners, you’ll need to register for a DBA (doing business as) designation, first making sure that no other company is already using the name you choose and then registering your DBA with the state.
While the owners of a General Partnership do not need to register their business, they should have a clear understanding of how the business is owned, how it will operate, and the responsibilities and decision-making authorities of each person. It’s not legally required, but every Partnership should have a solid Partnership Agreement to keep everyone on the same page regarding rules and responsibilities. Let’s look at what should be included in that agreement.
Partnership Pros and Cons
Partnerships are popular business entities with entrepreneurs for a variety of reasons:
- Added knowledge and experience – Working with one or more partners brings together people with different skills, knowledge and experience. A big-picture visionary is likely to benefit from working with someone who loves to crunch the numbers and keep track of compliance issues.
- More connections – Having more than one person in a business increases the number of connections with people who may be able to help you get the word out about your product or service or recommend potential customers.
- Shared workload – Running a business requires a lot of juggling of tasks. Having one or more partners enables you to divide the work and lighten the load.
- Shared financial burden – You and a partner can share costs for startup, inventory, equipment, physical space, and other expenses. That could enable you to get your business up and running more quickly while avoiding excessive debt.
- Quick and easy to start – General Partnerships are easy to get started, as there’s no paperwork to file with the state or fees you must pay. As you read earlier, however, you’ll need to file a DBA, if applicable, and make sure you get any necessary licenses or permits.
As with any business structure, there are some disadvantages to Partnerships, the biggest of which, in some cases, is unlimited liability for owners:
- Unlimited liability – Like Sole Proprietors, the members of a General Partnership are not considered separate from the business. There is no distinction for legal purposes, which means the personal assets of owners can be in jeopardy if the business is sued or can’t repay its debt. If there are not sufficient business funds to settle the lawsuit or repay the debt, assets such as the owners’ homes and bank accounts could be at risk. Partners can protect themselves somewhat by obtaining business insurance and keeping it up to date, but a General Partnership cannot offer the advantages of other types of Partnerships or a Limited Liability Company (LLC) or Corporation, which are types of business entities that are registered with the state and enjoy various legal protections.
- Potential for conflict – Two or more people working together always raises the potential for conflict, whether it’s regarding how money is spent, responsibilities divided, or another matter. Preparing for these situations by having a good Partnership Agreement in place can make conflicts easier to deal with.
- Need for shared decisions – While sharing decision making can be beneficial, needing to obtain input from others can slow things down and be frustrating to an entrepreneur who’s used to making decisions on their own.
- Sharing profits – While a Sole Proprietor keeps all the profits of a business, money earned in a Partnership must be divided among members, which can be a source of frustration if one member believes they are contributing more than others. How profits are divided is an important topic to be covered in your Partnership Agreement.
Different Types of Partnerships
While General Partnerships are a common business structure among entrepreneurs, there are other varieties of Partnerships, as well. Let me recap the characteristics of a General Partnership and then we’ll look at three other types.
General Partnership
As you’ve read, a General Partnership is simply a business in which two or more people agree to work together. The business does not have to be registered with the state and there is no limit to the number of people who can serve as partners. Profits are shared equally between partners unless otherwise specified, and all members normally have equal power to secure contracts or financing. Responsibility for the company’s debts and legal obligations also is shared equally. Partners are not considered to be employees of the company, but are paid by taking owner draws, which are funds taken from the business for personal use. A General Partnership is a pass-through entity, which means partners report their share of business income and losses on their personal tax returns and are taxed at their individual tax rates. The business itself does not pay income tax.
Limited Partnership
Unlike a General Partnership, a Limited Partnership is a formal business entity that is registered with the state and subject to state laws and regulations. This type of business structure has at least one general partner who is responsible for managing the day-to-day operations of the business, and one or more limited partners, who invest in the business but cannot participate in day-to-day management, as doing so would cause them to lose their limited partner status.
Limited Partnerships are popular with entrepreneurs who need investors to help fund their businesses but wish to avoid the expense and compliance requirements involved with starting a Corporation or LLC. General partners have unlimited liability if the business is sued or can’t pay its debts, while limited partners are only liable to the amount they invested in the company.
Limited Liability Partnership
A Limited Liability Partnership must be registered and operate within the requirements of the state. This business structure is primarily utilized by professionals such as physicians, attorneys, accountants, and architects who want to limit their personal liability for the actions of other partners. If one partner is charged with malpractice, other partners cannot be held responsible. Members of a Limited Liability Partnership also are protected from debts incurred by the business.
A Limited Liability Partnership must have two or more partners, all of whom are considered general partners. This type of Partnership is not permitted in every state, and some states limit it to specific industries. The amount of personal liability protection afforded to each partner also varies from state to state.
Limited Liability Limited Partnership
A Limited Liability Limited Partnership is a relatively new type of business structure that’s most often found within the real estate industry. While in a traditional Limited Partnership the general partner or partners can be held personally liable if the business is sued or can’t repay debt, a Limited Liability Limited Partnership provides liability protection for general partners. This type of business entity, which is not permitted in every state, is a popular option for investor groups working on large projects such as hotels, commercial buildings or apartment complexes.
Steps for Starting a Partnership
Regardless of the type of Partnership you’re planning to start, there are certain considerations to keep in mind:
- Verify potential partners – Even if you’ve worked with potential partners and known them for a long time, it’s never a bad idea to take some extra steps to make sure you won’t be surprised. Consider using one or more of the available credit agencies to run a credit check on each person and check their social media to make sure everything is in line with your expectations and values.
- Decide what type of Partnership you’ll have – You’ll need to find out what types of Partnerships are permitted in your state and then decide which of the four types described earlier is best suited for your business.
- Agree to the terms of your Partnership Agreement – You’ve already read how important this agreement is. Be sure everyone is on board regarding contributions and shares, roles and responsibilities, how conflicts will be handled, and other matters.
- Confirm your business name – Choose a name and, if it’s different from the legal names of partners, check to see if it’s available and file for a DBA, if applicable.
- Register with the state, if necessary – If your state requires the form of business entity you’ve chosen to be registered, you’ll need to file the necessary paperwork and pay any fees that apply.
- Obtain an Employer Identification Number – EINs are required for all Partnerships, so you’ll need to apply for one from the IRS. It’s a free, simple process and you’ll get the number immediately. You’ll need an EIN to open a business bank account, hire employees, and file tax returns.
- Obtain necessary licenses and permits – These may be issued by your local, state, or federal government, depending on your industry and other factors. Be sure to find out what you need.
- Seek assistance when needed – Starting a business of any sort can be stressful, and you want to make sure you get it right. Don’t hesitate to contact legal or financial help when you need to.
FAQs About Partnerships
How Do I Know If I Have a Partnership?
State laws govern the creation, organization, and dissolution of Partnerships. What constitutes a partnership varies by state but usually includes an agreement between individuals, companies, and corporations—or any combination of those parties. Whether or not there is a formal partnership agreement, a court has the final say. Courts determine whether a partnership exists by looking at the parties’ intentions, the sharing of profits and losses, the existence of joint administration and control, what the capital investment is by each partner, and the common ownership of property.
Do I Need a Federal Tax ID for a Partnership?
Partnerships are required by law to obtain a Federal Tax ID number. You can apply for your tax ID number through the IRS website, or you can let CorpNet apply for you. Having us help you can help save you time and money, and we can bundle your Federal Tax ID Number with one of our other business filing services. A tax ID number is required to open a business bank account and on all Partnership tax returns.
How Do I File Taxes as a Partnership?
Partnerships file taxes using Form 1065, U.S. Return of Partnership Income. The annual return reports the partnership’s income, deductions, gains, losses, etc., from its operations. However, the Partnership does not pay income tax; instead, it passes its profits or losses onto its partners. Partners then report their share of the business’s income or loss on their personal tax returns. This “pass-through” obligation is the same tax structure for Sole Proprietorships and avoids corporations’ double taxation. Partners are not employees and therefore should not be issued a W-2. The Partnership furnishes copies of Schedule K-1 (Form 1065) to the partner.
Putting it all Together
Starting a Partnership can be an exciting and rewarding venture, providing an opportunity to launch a business that you and your partners can nurture and grow. Just be sure to do your homework ahead of time and follow all the steps necessary to get your business off to a great start.
Don’t assume there are no compliance issues to consider, even if your business is a General Partnership that doesn’t need to be registered with the state. Stay organized, know what’s required, and reach out for help if you’re not certain about how to proceed.
