Partnership Business Entity: Everything You Need To Know
A partnership business entity is a business consisting of two or more owners who run their business in accordance with the terms of a partnership agreement.3 min read
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.
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.
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.
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.
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.
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.
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.
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