Key Takeaways

  • A partnership business is formed when two or more individuals agree to manage and share profits, losses, and responsibilities.
  • General partnerships are inexpensive and flexible but expose partners to personal liability.
  • Taxation is pass-through, meaning profits and losses flow to each partner’s individual return.
  • Variations include limited partnerships (LPs) and limited liability partnerships (LLPs), which reduce liability for some or all partners.
  • Successful partnerships require clear agreements, communication, and dispute-resolution mechanisms.
  • Alternatives such as corporations, LLCs, and sole proprietorships may provide more liability protection or different tax treatment.
  • Preventing disputes involves written agreements, defined roles, exit strategies, and legal counsel.

A partnership business entity, or a general partnership, is a business consisting of two or more owners who run their business in accordance with the terms of an oral or written partnership agreement. Although an agreement is not required, it makes sense to have one so that the partnership will run smoothly.

Characteristics of a General Partnership

Simply co-owning rental property or sharing expenses does not constitute a partnership for tax and legal purposes. To determine whether a partnership exists, authorities consider:

  • Whether a partnership agreement exists and if the partners have adhered to its terms.
  • The parties' relationships with one another.
  • What each person contributes to the partnership.
  • The level of control each person has over the income of the partnership and how it is used.

Every partner may enter contracts on behalf of the business unless the partnership agreement states otherwise. Partners are jointly responsible for all business debts, obligations, and liabilities. This means that personal assets can be seized to pay these obligations.

Types of Partnership Business Structures

While general partnerships are the most common, there are several partnership business structures that entrepreneurs may choose from:

  • General Partnership (GP): All partners share management responsibilities and liability.
  • Limited Partnership (LP): At least one general partner manages the business and assumes full liability, while limited partners contribute capital and are only liable for their investment.
  • Limited Liability Partnership (LLP): Provides liability protection for all partners, shielding their personal assets from many business debts and claims.
  • Joint Ventures: A temporary partnership formed for a specific project or goal, often dissolved after completion.

Advantages of a General Partnership

With a general partnership, you can take advantage of a lean business model and make fast decisions on behalf of growth. This type of entity is usually inexpensive to create, though you may want to hire an attorney to draft a general partnership agreement.

Keys to a Successful Partnership Business

The success of a partnership often depends on non-legal factors, including:

  • Trust and Communication: Open communication and mutual trust are essential.
  • Defined Roles: Clarifying responsibilities prevents confusion and overlap.
  • Shared Vision: Aligning on long-term goals ensures partners move in the same direction.
  • Conflict-Resolution Plans: Establishing methods to resolve disagreements before they escalate.

Partnership Taxation

Partnerships are taxed as pass-through entities, which means that each partner reports a share of business profits and losses on his or her individual tax return. The business itself is not subject to income tax at the corporate level, though state and local taxes may apply. As with sole proprietorships, some business expenses can be deducted depending on the specifics of your personal return.

A partnership should file with the IRS for an employer identification number (EIN). You can also use your Social Security number to pay taxes and open a business bank account. You can get a free EIN by submitting Form SS-4 on the IRS website. If you opt to change your business entity at any time, you'll need to get a new EIN.

Recordkeeping and Compliance for Partnerships

Partnerships must keep accurate records for tax reporting and business management. Best practices include:

  • Maintaining a separate partnership bank account to distinguish personal and business finances.
  • Using written agreements to document capital contributions, distributions, and partner loans.
  • Keeping records of partnership meetings and major business decisions.
  • Filing necessary state registrations where required, such as annual reports or business licenses.

Disadvantages of a General Partnership

The main negative aspect of a general partnership is the liability that partners must assume for business debts and obligations. This means creditors can seize not only the business assets but also partners' personal assets.

To avoid this risk, some entrepreneurs establish a limited partnership. With this structure, general partners still carry personal liability but limited partners are only liable for the amount of their financial investment in the business.

Common Causes of Partnership Disputes

Disputes among partners can threaten the stability of the business. Frequent causes include:

  • Unequal contributions of capital or effort.
  • Disagreements over strategic direction or business priorities.
  • Perceived imbalance in profit-sharing.
  • Breach of fiduciary duty by one or more partners.
  • Exit or succession planning conflicts.

Limited Liability Partnerships

In most states, limited liability partnerships (LLPs) can register with the state. With this structure, each partner's liability for business debts and obligations is limited to his or her direct actions.

Partnership Agreements and Legal Protection

Even in LLPs or LPs, a written partnership agreement is critical. It should address:

  • Decision-making authority and voting rights.
  • Capital contributions and distribution of profits.
  • Buyout and dissolution provisions for departing partners.
  • Restrictions on transfers of ownership interests.
  • Non-compete or confidentiality clauses to protect business interests.

Corporations

When you establish a corporation, you create a completely separate legal entity. This business structure is owned by shareholders and managed by officers and directors. Corporations can independently sue and be sued, buy and sell property, and enter contracts.

Corporations must abide by stringent state guidelines about their governance. In most cases, shareholders have limited liability for corporate debt.

A corporation can be either a C or S corporation. S corps are taxed like partnerships and carry certain eligibility requirements that include:

  • Shareholder residency status.
  • Stock classes.
  • Number of shareholders.

Limited Liability Company (LLC)

An LLC is a business entity that provides limited liability and can consist of one or more individuals. However, they avoid the strict management requirements associated with corporations. An LLC has owners known as members and may also have separate managers and employees. Like a corporation, this structure is treated legally as a separate entity. An LLC can file taxes as a partnership or as a corporation. The structure of this type of company can be more flexible than that of a corporation.

Sole Proprietorship

Also called a sole trader, a sole proprietorship is owned by just one person. He or she carries sole legal responsibility for all business obligations. The business does not exist as an entity that is distinct from the owner, who keeps all business profit and has full control over the business's operations.

Frequently Asked Questions

  1. What is a partnership business entity?
    A partnership business is formed when two or more people agree to run a business together, sharing profits, losses, and management responsibilities.
  2. Do partnerships require a written agreement?
    While not always legally required, a written partnership agreement is strongly recommended to prevent disputes and clarify roles.
  3. How is a partnership business taxed?
    Partnerships use pass-through taxation, meaning profits and losses flow directly to each partner’s individual tax return.
  4. What is the difference between an LP and LLP?
    In an LP, limited partners only risk their investment while general partners have full liability. In an LLP, all partners enjoy some liability protection.
  5. How can partners avoid disputes?
    Clear agreements, defined roles, regular communication, and legal safeguards—such as dispute resolution clauses—help prevent partnership conflicts.

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