What is a Partnership?
A partnership is a formal legal entity where two or more parties agree to manage and operate a business and share its profits and losses. Like a sole proprietorship, each partner is responsible for the assets and liabilities of the company. However, in a partnership, the parties create a partnership agreement that dictates ownership, responsibilities, and decision-making authority. While there are no specific filing or registration formalities needed to start a partnership, partnerships must comply with the registration, filing, and tax requirements required of any business.
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.
What Is the Difference Between Being Self-employed and Forming a Partnership?
Most new small businesses choose to start as a sole proprietorship, an unincorporated business entity formed by an individual business owner. If a married couple owns the sole proprietorship, legally, one must be designated as the owner, while the other is considered an employee. In a sole proprietorship, the business and its owner are considered the same legal and tax-paying entity. Sole proprietors own all of the business’s assets and profits and are wholly responsible for all its liabilities and debts. If an entrepreneur does not file formal business formation documents with the state, the business is considered a sole proprietorship by default.
If there is more than one owner, then the business is considered a partnership. If a married couple owns the company and both want to be regarded as owners, then the business is a partnership, as are all businesses where two or more parties own and operate the company. When two or more people run an unregistered company, the business is considered a general partnership by default.
Like in a sole proprietorship, a partnership has no distinction between the business and its owners. The owners and the company are considered the same legal and tax-paying entity, and the individuals in the partnership share legal, financial, and management responsibilities for the business. Partnerships usually have an agreement that spells out the division of ownership and duties among the business owners.
In a sole proprietorship, one sole owner carries full responsibility for all of the business’s assets, profits, and losses. In a partnership, each partner accepts equal responsibility unless the business’s partnership agreement modifies the partners’ ownership allocation.
Operating as a sole proprietorship provides no personal liability protection for the business owner. If the business can’t pay its debts, creditors can go after the owner’s personal assets (such as home, personal bank accounts, cars, retirement funds, etc.) to collect what’s owed to them. In court, a judgment against a sole proprietorship is a judgment against the owner. For this reason, sole proprietorships need to have comprehensive personal liability insurance to provide some protections for claims involving injury, property damage, and unintentional professional mistakes.
In a general partnership, all partners are liable for any acts, legal wrongdoing, or debts incurred by any of the business partners. All partners’ personal assets are equally at risk. They are responsible for the business’s debts and legal judgments unless there are modifications in the partnership agreement or the company is legally a different type of partnership.
What Are the Different Types of Partnerships?
There are four different types of partnerships.
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.
Does a Partnership Need a Business Name?
By default, the legal business name of a general partnership consists of the partners’ last names. However, most partnerships prefer to choose a business name that connotes the business brand and describes what the business does. Once the name has been decided, it is written into the formal partnership agreement and used in all documentation related to the company, such as bank accounts, tax forms, and business licenses and permits. If the partnership decides to use a different name from the owners’ names, the partnership must file a DBA. A DBA (Doing Business As) is a fictional name or trade name the business wants to use when marketing itself to the public and dealing with customers.
How Do I Form a Partnership?
Because a general partnership is not a formal business entity like a Limited Liability Company or C Corporation, there are no requirements for filing business registration paperwork with the state. As stated above, if the partnership does not want to include all of the partners’ last names in the business name, they must file a DBA with the state or the county clerk—depending on the business’s location. Then, to specify the division of ownership and duties, the partners should draft and sign a detailed partnership agreement.
The formation rules of a limited partnership, a limited liability partnership, or a limited liability limited partnership depend on your business’s location. For limited partnerships, most states require filing a “Certificate of Limited Partnership,” a document similar to the Articles of Organization required of a limited liability company.
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.
What Should Be Included in a Partnership Agreement?
Creating a partnership agreement is crucial to forming the partnership and shaping its future, especially when an inevitable conflict appears. Typically, a partnership agreement includes:
- The businesses legal name and trade name (if there is one)
- Contributions made by each partner
- Future financial obligations
- Rules for profit distribution
- Dispute resolution
- Decision-making powers
- Actions to be taken in case of a partner illness or death
- Dissolution of the partnership procedure
The partnership agreement is a fluid document, so it needs to specify the circumstances under which the agreement can be modified and who has the authority to alter the document. Be sure to obtain an attorney’s services to help you draft a partnership agreement, preferably one who understands your industry.
For help in all other aspects of forming your partnership, from business licenses to filing for a DBA, CorpNet is here to help get your business up and running.