Key Takeaways

  • A general partnership in California is formed automatically when two or more people carry on a business for profit, with or without a written agreement.
  • While not required, a written partnership agreement in California is essential for defining rights, roles, and responsibilities.
  • Partners are jointly and severally liable for debts and obligations unless structured otherwise.
  • Partnerships must register a fictitious business name if they use a name other than the partners' legal names.
  • Tax reporting is done via Form 565, and profits/losses pass through to partners for tax purposes.

The California general partnership law specifies that the partnership is between two or more persons who will work together as co-owners of a business with the goal being to make a profit.

Overview of the California General Partnership Law

A partnership may be either limited or general. The partnership is a separate entity distinct from its partners.

Limited Liability Partnership

In California, a limited liability partnership (LLP) business structure is an option. It provides limited liability protection for all its partners. An LLP is limited to professionals such as architects, CPAs, and lawyers. Until January 1, 2019, engineers and land surveyors are also allowed to form an LLP.

General Partnerships

The "persons" in a general partnership may include individuals as well as other business entities. When a partnership is formed, most partners will create a formal partnership agreement that outlines each partner's rights and obligations. Creating and signing an agreement is not a requirement; a partnership can be established with just a handshake.

The laws relating to general partnerships in the state are outlined in the California Corporations Code, Title 2. Should a dispute arise as to the validity of the partnership, a partnership agreement is usually the determining factor used to establish its existence.

There is no limitation to the type of trade, profession, or occupation a general partnership may engage in. For information, see Corp. code 16101(1), (9). In the event that a general partnership is to engage in the banking business, the corporation would need to be organized for that structure. See Fin. Code 102.

All partners in a California general partnership are considered joint owners of the business. Each has an equal right in the company's management unless noted otherwise, and each share in the business's profits and losses in relation to what they contributed financially to the business. All partners in a general partnership are bound by the acts of another partner regarding partnership business unless the partner does not have the authority to act on behalf of the business and the other party is aware of this fact.

The formation of a general partnership is easier to organize than a corporation or a limited partnership. The arrangement of capital contributions, managing operations, management control, and the sharing of profits and losses is relatively simple to organize.

Legal Requirements to Form a California Partnership

California law does not require a written agreement to form a general partnership—merely the intent to carry on a business for profit as co-owners. However, certain formalities should still be considered to ensure proper formation and operation:

  • Fictitious Business Name Registration: If the partnership name differs from the partners' legal surnames, it must be registered as a “Doing Business As” (DBA) name with the county clerk where the partnership operates.
  • Business Licenses and Permits: Depending on the type of business, local and state permits may be required.
  • Employer Identification Number (EIN): Partnerships typically must obtain an EIN from the IRS for tax and employment purposes.
  • Optional Partnership Statement: Under California Corporations Code §16303, a general partnership may file a Statement of Partnership Authority with the Secretary of State to establish who is authorized to act on behalf of the business.

Why a Written Partnership Agreement Matters

Although a general partnership can be formed without a written agreement, having one is highly recommended. A well-drafted partnership agreement in California provides clarity on:

  • Capital Contributions: Specifies what each partner contributes to the business (e.g., cash, property, services).
  • Profit and Loss Sharing: Clarifies how income and losses will be distributed, which may differ from the default equal-share rule.
  • Decision-Making Authority: Defines how decisions are made and who has authority over specific aspects of the business.
  • Dispute Resolution: Includes procedures for resolving disagreements, such as mediation or arbitration clauses.
  • Exit Strategy: Outlines what happens if a partner dies, withdraws, or wants to sell their interest.

Without an agreement, default rules under the California Revised Uniform Partnership Act (RUPA) apply, which may not reflect the partners’ intentions.

Advantages and Disadvantages of a General Partnership

Advantages

  • Easily established.
  • Registering the partnership with the Secretary of State is not required.
  • No filing fees.
  • All profits and losses are passed through to each partner according to their percentage invested in the partnership.
  • Partners, not the business, pay income tax on the profit.
  • Multiple owners improve the chances of raising capital due to greater access to resources.
  • The success level is high for the partnership because multiple partners bring more ideas to consider.

Disadvantages

  • Each partner is jointly liable for the actions/conduct of the other partners and any debts or other legal obligations related to the business.
  • The personal liability of each partner is unlimited, meaning each partner's personal wealth is at risk. This can be helped with liability insurance.
  • Before any partner's interest in the business can be transferred, it must be unanimously approved by all partners.
  • In the event of the death of a partner or a partner who wishes to withdraw from the partnership, the business is dissolved. It can be formed again as a new business with the remaining participating partners.
  • If the company name is anything other than the names of the partners, it must be registered as a fictitious name. This is also known as a "doing business as" name. The name must be registered in the county where the principal place of business for the partnership is located.
  • With the absence of a written general partnership agreement, the company is subject to potential problems.

Key Considerations When Drafting a Partnership Agreement

A California partnership agreement should address these critical issues:

  1. Ownership Percentages: Clearly outline each partner’s stake in the business.
  2. Roles and Responsibilities: Define each partner’s duties, work expectations, and decision-making powers.
  3. Banking and Financial Authority: Specify who can access bank accounts and authorize expenses.
  4. Admission of New Partners: Detail how and under what conditions new partners can join.
  5. Non-Compete or Confidentiality Clauses: Protect business interests by limiting partner activities outside the partnership.
  6. Buyout Provisions: Include terms for buying out a departing partner’s interest.
  7. Dissolution Terms: Describe the process for winding down or exiting the partnership.

These provisions help reduce the risk of costly legal disputes and ensure smooth operations.

General Partnership Tax Process

As noted, a general partnership is not a taxable entity. Instead, the partnership must file information returns annually that outline the company's income, profits, and losses.

The state tax authorities for California do not levy income tax on a general partnership, but every partnership that does business in California or earns an income in the state should file Form 565 (Partnership Return of Income). General partnerships may be subject to other rules and regulations depending on the type/nature of the business.

Terminating or Dissolving a California General Partnership

A general partnership in California can be dissolved in several ways:

  • Voluntary Dissolution: Partners may agree to dissolve the business, typically outlined in the partnership agreement.
  • By Law: If the business becomes illegal or all partners leave, the partnership is automatically dissolved.
  • Judicial Dissolution: A partner may petition the court to dissolve the partnership due to misconduct or deadlock.

Steps include:

  1. Cease Operations: Stop business activities and notify clients/customers.
  2. Notify Creditors and Settle Debts: Pay all outstanding obligations.
  3. File Final Tax Returns: Ensure all tax filings, including Form 565, are submitted.
  4. Distribute Remaining Assets: Based on the terms of the agreement or California default rules.
  5. Cancel Licenses/DBA: Notify relevant agencies of the business closure.

Frequently Asked Questions

  1. Is a written partnership agreement required in California?
    No, but it is strongly recommended to prevent misunderstandings and legal disputes.
  2. Can a partnership in California be formed without filing anything with the state?
    Yes. No formal filing is required to create a general partnership, though some documents (like a DBA or business license) may still be necessary.
  3. How are profits divided in a general partnership?
    By default, profits are shared equally, but partners can agree to a different allocation in the partnership agreement.
  4. What happens if a partner wants to leave the partnership?
    If addressed in the agreement, the buyout or withdrawal terms will apply. Without one, the partnership may be dissolved.
  5. Do general partnerships pay income tax in California?
    No, but they must file an informational return (Form 565), and each partner reports income on their personal tax return.

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