General Partnership: Everything You Need to Know
general partnership is a business with two or more members that has not filed for “limited liability company” LLC status.7 min read
A general partnership is a business with two or more members that has not filed for “limited liability company” LLC status.
What is a 'General Partnership
The simplest and least expensive business structure to create and maintain is a general partnership. A general partnership provides members “agency powers,” binding contract to a partnership agreement. Partnership is the sum of all partners; each with the equal right to participate in the management and control of the business, unless stipulated otherwise. Percentage of ownership may also be affected by articulation of distributive share proportional to the capital basis a partner is entitled to. Investment, contribution of time, or assumption of liability are all reasons a partner will attain disproportional rights to a partnership and its value. In such case a limited partnership may be in place, covering short duration or service oriented contracts.
Members are responsible for the discretionary inclusion of partners. New members require the consent of all parties. Disagreements between partners in general partnership are resolvable by majority rule, vote, or dispute resolution. The complications of bureaucracy associated with corporate structures is often cited as the reason for forming a general partnership.
Assignment of a share of rights to distribution or transferrable interest by a partner, can be used to satisfy a judgement against that member, if met with agreement by the other partners. Unlike LLC entities, general partnership members have unlimited liability for business dealings and debts. Therefore, any member can be assigned the full liability of business debt in a lawsuit.
A general partner is an owner of a partnership with full entitlement and unlimited liability for the business. General partners are typically managing partners.
Personal Liability for All Owners
The downside of general partnership is that the personal assets of that member are subject to liquidation to meet the partnership's financial obligations if the business is sued. Partners are personally liable for all court judgements and business debts. Obligations to compensatory damages from a court judgment, or to collectible debt when a creditor has not been paid can be stiff. LLC partnerships protect partners from personal obligation to legal and debt issues from a business. Some states provide for special limited liability partnerships (LLPs), distinct from LLCs and other business entities. LLPs are firms established as general partnerships. Attorney groups are often LLPs.
The benefit of partnership is joint authority in a discretionary business arrangement that has the potential to create prosperity for all involved. Negotiating a deal, a single member can bind a partnership to contract with vendors or external business agreements. Exception to this rule, partners cannot bind the partnership to sale or transfer of all assets accorded the business with unanimous decision by all partners. General partnerships are tax-exempt, “pass through” entities obligated to Internal Revenue Service tax filing solely for the purposes of information. The authority to make decisions extends to the area of deductible business expenses. Partnerships are not taxed, and all income flows to partners. Distributed shares of profits and losses, as well as allocations set aside separate from ratio of capital basis, are reported by individual partners in personal tax return filings.
Partnership owners have unlimited personal liability, and each is jointly liable for the partnership's obligations. There are three obligations to a partnership: 1) Each partner is liable for their own actions; 2) Each partner is liable for actions taken by the other partners; 3) Each partner is liable for actions taken by employees on behalf of the business.
Financial responsibility, including debt, is the obligation of all partners. Partners are individually liable for debts incurred by a partnership during business operations.
Joint liability is a tort law rule that assigns full responsibility to each and all partners in case of a lawsuit. Partners are liable as group when the partnership is sued. Litigation is a risky liability for partnerships. Each individual partner is obligated to pay a distributive share percentage for compensatory damages, or potentially the full amount of any business debt. Joint and several liability rules in some U.S, states, make each partner both jointly and severally liable for any damages resulting from the wrongdoing of other members.
A partnership is not a taxable entity, or separate from its owners according to the IRS. Partnerships are tax-exempt, tax-reporting entities. Profits pass through the partnership to the partners, who as the owners responsible for filing individual tax return Form 1040 and Schedule SE Self-employment information. Partners claim deductible business expenses as part of their individual tax returns, which in turn reduces the total net income of the business. Schedule SE demands double contribution by partners to Social Security and Medicare, as owners are not employees. The IRS provides Schedule SE filing taxpayers with a 50 percent tax deduction of those contributions, however. Partnerships must file IRS Form 1065, an informational return of profits and losses of the business; and a Schedule K, accompanied by K-1 filings for each partner reporting distributive share of income and losses, as well as allocations.
The IRS treats limited partnerships as partnerships, and requires that each partner make quarterly estimated tax payments based on distributive share percentage assigned in the partnership agreement. Actual allocations are not reported in the quarterly estimated tax payments to the IRS, and instead are reported at the end of the tax year. The IRS considers partner equity to be the basis to the quarterly estimated tax payment obligation, regardless if the partner is receiving income from the partnership or not. Distinct from general partnerships, the limited partnership defines only one partner as the general partner, who in turn assumes unlimited. In this case, the general partner is entitled to a larger share of the partnership, and this should be articulated in the partnership agreement.
Risk and Control in Partnership
Risk and financial control are the most common liabilities to partners involved in a partnership agreement.
Fiduciary Duty in Partnership
Partners owe both a contractual and fiduciary duty to the partnership. Fiduciary duty is obligation to the partnership’s benefit; confining personal interests to those outlined in the partnership agreement. Subordination of personal benefit in the interests of the partnership, exhibits performance of fiduciary duty.
Benefits of General Partnership
General partnerships are set up to support the business interests of two or more mutually assenting to owners, who seek to derive benefit by bringing specialized knowledge and skills to the agreement. A general partner under the structure and control of the terms stated in the partnership agreement, can expect equity in sharing of benefits established as an asset of the business, or generated as profit as result of a partnership’s efforts.
Creating a Partnership
Formation of a new partnership requires a partnership agreement, including written execution of partners’ rights and responsibilities, as well as definition of distributive share and capital basis. Partnership operation typically requires that the “entity” must meet state, county, and municipal registration, licensing, and permit rules. Business activities associated with “doing business as” DBA fictitious business name, rather than a title including the names of the partners, must be registered with the county clerk where the partnership is maintained to comply with rules to DBA operators.
Forming an Agreement
The partnership agreement is a legal document that serves to legitimate the partnership. The agreement is a guiding framework for partner investment, business control and management. The agreement must include the partnership name and address; names and addresses of all partners; effective date and purpose; voting requirements; distributive share and capital basis of each partner. Financial information, auditing and profit reporting is required for IRS tax return documentation of contributions to or from any partners; as well as the deadline for completion of contributions. Conditions to termination of a partner’s membership and procedures covering partner withdrawal from the partnership, as well as guidelines to total dissolution must be included for a contract to be formalized.
Uniform Partnership Act (UPA)
The Uniform Partner Act covers joint tenancy, common property, and part ownership rules to establishing a partnership. Sharing of gross returns from jointly held investment property does not establish a partnership without formation. The Act outlines guidelines to forming a partnership. Written partnership agreement is recommended and should be done before a partnership commences to minimize disputes and liability flowing from business relations. Capital contributions, the basis of distributive share percentage, are generally stated in the partnership agreement. The nature and terms to other basis of distributive shares should be articulated in writing, in so far as the IRS and the partners understand rights and responsibilities to the partnership and its debts. Guidelines for distribution of assets upon dissolution of the agreement should all partners decide to terminate the partnership, should be clearly stated.
Distrubution of Assets
Partnership agreements containing the right of first refusal, the provision that requires a terminating partner to offer the remaining partners the option of buying those shares of the business at the price of a bona fide external offer. Right of first offer requires the departing partner offer to sell assigned share of the partnership to the other partners, prior to selling it externally. Partners may opt to sell at Dutch auction price to another partner. A third-party arbitrator skilled at valuation, may be contracted to set the price.
Ending a Partnership
Dissolution of partnership membership by one partner, does not mean total dissolution of a partnership, unless agreed to by all partners. Ending a partnership requires that the partners fulfill remaining business obligations, pay all debts, and divide profits and assets with equity, or according to distributive share percentage. A buy-out agreement or buy-sell agreement, summarizes remaining obligations that the leaving partner(s) may hold as part of the partnership. The conclusion of a partner’s participation due to death, retirement or other circumstance such a disability, is made easier with a buyout agreement. Deceased parties may also be assigned benefits of a partnership at the time another partner terminates, if it is on record in the partnership agreement that membership was in perpetuity. Sustained partnership after death, transferring profit or losses to deceased partners only has an impact where beneficiaries of an estate have a right to partnership assets.
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