What Is a Partnership Business?

Key Takeaways

• A partnership business involves two or more people sharing profits, losses, and responsibilities.
• Types of partnerships include general partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs).
• Benefits of partnerships include simplicity, combined resources, and flexible management structures.
• Partnership agreements clarify ownership stakes, decision-making powers, and profit-sharing models.
• Federal tax responsibilities for partnerships include filing an annual return and issuing Schedule K-1 to partners.
• Common challenges include unequal participation, personal liability, and disagreements over business direction.

The purpose of partnership agreement (or partnership contract) is to establish a business enterprise through a legally binding contract between two or more individuals or other legal entities. This partnership agreement designates the rights and responsibilities of each partner or entity involved.

Types of Partnerships

There are a few different types of partnerships, the most common of which is a partnership between individuals. A partnership may also be made up of other types of legal entities, such as corporations or LLCs.

The partnership agreement includes the following elements:

• Names and contact information of each individual partner
• Purpose of the partnership and primary place of business
• Designated terms of ownership
• Amount of capital each partner invests in the business
• Partnership shares
• Directives about the distribution of profit among partners
• Company management
• Operation details

By establishing the partnership as a separate legal entity, individuals take advantage of the ability to separate personal assets from the business created. Partnership agreements require less complicated procedures than a corporation. A partnership is not required to file articles of incorporation with the government or keep corporate minutes.

Developing a partnership agreement with specific provisions allows the partners to develop and operate their business to their own objectives and desires, rather than being restricted by the law's default provisions, as governed by the state where the business operates.

It is not necessary or required to split up the company so that each partner owns an equal share. Through the partnership agreement, partners can choose to divide ownership interest in whatever way they see fit, so long as there is agreement among partners. It's also not necessary that all partners be actively involved in operating the business. A partnership agreement can designate a partner as an investor only.

Key Characteristics of a Partnership Business

A partnership business is formed through a legal relationship where two or more individuals agree to carry on a trade or business together. Unlike corporations, partnerships are relatively simple to establish and operate. Some defining features include:

• Shared Ownership: Each partner contributes to the business, whether through capital, labor, skills, or other resources, and shares in the profits and losses.
• Joint Control: Partners jointly make decisions and manage the business, though specific roles and responsibilities can be defined in a partnership agreement.
• Pass-Through Taxation: Partnerships do not pay income tax at the business level. Instead, profits and losses are passed through to partners, who report them on their personal tax returns.
• Unlimited or Limited Liability: In a general partnership, all partners typically share personal liability for business debts and obligations. However, LLPs and LPs offer varying degrees of liability protection.

Common Types of Partnership Structures

In the United States, several forms of partnership business structures exist, each with its own legal and operational implications:

1. General Partnership (GP): All partners share equal rights and responsibilities in managing the business and are personally liable for business debts.
2. Limited Partnership (LP): Includes both general and limited partners. Limited partners contribute capital but typically do not engage in day-to-day operations and have liability limited to their investment.
3. Limited Liability Partnership (LLP): Often used by professionals like lawyers and accountants, LLPs protect each partner from liabilities arising from another partner's negligence or misconduct.
4. Joint Ventures: A temporary partnership formed for a specific project or goal. Once the objective is achieved, the joint venture typically dissolves.

Choosing the appropriate structure depends on the nature of the business, number of partners, liability preferences, and long-term goals.

Why Establish a Partnership?

Many individuals and even many businesses don't often make a partnership agreement before conducting business together, which can be a costly mistake. Many partners already have an existing, long-term relationship and don't foresee any issues arising in the future. Many family-owned small businesses simply don't recognize the necessity of a partnership agreement. However, families, as well as any other business or company partner relationships, are prone to disagreements, which may even result in legal action against one another.

A partnership agreement is designed to prevent internal legal problems and disagreements by clearly designating the roles of individual partners and the business operations. In addition, the establishment of a partnership is easy and offers each partner the advantages of working with larger amounts of capital, experience, and other resources. A partnership agreement is a document that can be used in addition to the state's legal forms required for establishing a partnership, although it is not required.

Information included in the partnership agreement can prepare each partner for anything that may occur, so long as the parameters defined are legal according to state statutes and federal laws. As an example, the partnership agreement cannot state that each partner is only liable for the business decisions he or she enacts individually. This is due to the Uniform Partnership Act, which states that each partner is liable for their own actions in addition to the actions of other partners and company employees.

In addition, partnership agreements can greatly impact the partnership's and individual partners' taxation. The amount of tax that each partner pays, along with the type of payment and capital distributions, are outlined in the partnership agreement. Although the IRS does not require a copy of the partnership agreement, if a partner or the partnership's taxes are audited, a copy will be necessary.

Advantages of a Partnership Business

Many entrepreneurs choose to form a partnership business because it offers key advantages:

• Ease of Formation: Partnerships are typically easier and less expensive to set up compared to corporations.
• Pooling of Resources: Partners can combine financial, intellectual, and operational resources to grow the business more efficiently.
• Tax Benefits: Income is only taxed at the individual partner level, avoiding corporate double taxation.
• Shared Decision-Making: Collaboration among partners can lead to more well-rounded business strategies and solutions.
• Flexible Profit Distribution: Partners can divide profits and losses in any agreed-upon manner, not necessarily in proportion to ownership.

Potential Issues Arising From a Partnership

There are several common roadblocks that may arise and prevent you from working well with a potential partner. It's important to consider the likelihood of the following barriers:

• Lack of inspiration or vision
• Lack of defined purpose or lack of mutual understanding of purpose
• Domination by one partner or competition between partners
• Lack of commitment among all partners
• Lack of communication
• Lack of support from those with decision-making power
• Philosophical differences
• Lack of participation from key stakeholders
• Insufficient understanding of roles and responsibilities
• Overly burdensome financial and time commitments

Important Considerations Before Forming a Partnership

Before entering a partnership business arrangement, consider the following:

• Compatibility: Ensure all partners share similar values, goals, and commitment levels.
• Clear Roles: Define responsibilities and authority to avoid conflicts and duplication of efforts.
• Exit Strategies: Plan how partners can leave or dissolve the partnership, including buyout clauses.
• Conflict Resolution: Include a framework for resolving disputes in the partnership agreement.
• Legal and Financial Advice: Consult attorneys and accountants to structure the partnership properly and mitigate risks.

A well-structured partnership agreement can help prevent misunderstandings and protect all parties involved. If you need legal guidance, you can find an experienced attorney on UpCounsel to assist with forming or managing a partnership business.

Tax Obligations and Reporting for Partnerships

The IRS defines a partnership as a relationship between two or more people to conduct trade or business. For tax purposes, a partnership must:

• File Form 1065: U.S. Return of Partnership Income, which is an informational return submitted annually.
• Provide Schedule K-1s: Each partner receives a Schedule K-1 that outlines their share of income, deductions, and credits to report on their individual tax return.
• Maintain Records: Partnerships should maintain books and records that accurately reflect income and expenses.
• Register for EIN: Even though partnerships are pass-through entities, they must obtain an Employer Identification Number (EIN) from the IRS.

Although partnerships themselves don't pay income taxes, partners are personally responsible for taxes on their share of the profits, regardless of whether or not distributions were made.

Frequently Asked Questions

1. What are the main types of partnership business structures?
   General partnerships, limited partnerships (LPs), and limited liability partnerships (LLPs) are the most common types, each offering different liability and management structures.
2. Do partnership businesses pay income tax?
   No, partnerships themselves don’t pay income tax. Instead, profits and losses are passed through to the partners, who report them on their personal tax returns.
3. What should be included in a partnership agreement?
   A partnership agreement should cover roles and responsibilities, ownership interests, profit-sharing, dispute resolution, exit plans, and contribution expectations.
4. What are the risks of a partnership business?
   Common risks include personal liability for debts, disagreements between partners, and unequal contributions to work or capital.
5. How can partners resolve disagreements in a partnership?
   Ideally, the partnership agreement should include a dispute resolution process such as mediation, arbitration, or majority vote.

If you need help with a partnership, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.