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What is a Business Partnership?
As defined by the Internal Revenue Service, a business partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business. Another way of putting it is that a business partnership is a formal arrangement (a legal relationship) between two or more parties to manage and operate a business and share its profits or losses.
In a business partnership, business partners can be business entities or individuals. A partnership can include business entities as well as individuals. When forming a partnership, while it is not necessary to have a written partnership agreement , it is wise that the agreement be in writing.
Repeatedly, people enter into verbal partnerships agreements, something ends up going wrong, the partners are at each other’s throats and may even end up suing each other in court. With a written partnership agreement, the partners duties and responsibilities are explained, and the partners share of income and expenses is explained. All partnerships provide the advantage of pass-through taxation, which generally results in lower taxes than corporations.
Types of Business Partnerships
There are four types of partnerships. Following is brief description of those partnerships.
General Partnership (GP)
Although different terms may be established in the partnership agreement, ownership and profits are usually split evenly among the partners. In a general partnership , all partners have independent power to bind the business to contracts and loans. Each partner also has total liability, meaning that if you are a partner in this type of partnership, you are personally responsible, along with the other partners, for all the business’s debts and legal obligations.
Example, if a general partnership has four partners and one of those partners takes out a loan that the business cannot repay, all the partners may now be personally liable for the debt.
General partnerships are easy to form and dissolve. In most cases, the partnership dissolves automatically if any partner dies or goes bankrupt. This type of partnership consists of partners who participate in the day-to-day operation of the partnership and who have liability as owners for debts and lawsuits.
Limited Partnerships (LP)
Limited partnerships (LPs) are formal business entities authorized by the state. This type of partnerships has at least one general partner who is fully responsible for the business and one or more limited partners who provide money but do not actively manage the business.
Limited partners invest in the business for financial returns and are not responsible for its debts and liabilities. The silent partner limited liability means limited partners can share in the profits, but they cannot lose more than they have invested. In some states, limited partners may not qualify for pass-through taxation.
If you, as a limited partner begins to actively manage the business, you may lose your status as a limited partner, along with its protections. Some LPs appoint a limited liability company (LLC) as the general partner so that no one partner has to bear unlimited personal liability for the business. That option may not be available in all states.
Limited Liability Partnerships (LLP)
A limited liability partnership operates like a general partnership, with all partners actively managing the business, however, the partners liability for one another’s action is limited.
As a partner, you will still bear full responsibility for the debts and legal liabilities of the business, however, you will not be responsible for errors and omissions of other partners. This type of partnership is not permitted in all states and is often limited to certain professions, such as doctors, lawyers, and accountants.
Limited Liability Limited Partnerships (LLLP)
A limited liability limited partnership (LLLP) is a newer type of partnership available in some states. This type of partnership operates like an LP, with at least one general partner who manages the business, but the LLLP limits the general partner’s liability so that all partners have liability protection.
LLLPs are currently authorized in the following states:
- North Carolina
- North Dakota
- South Dakota
Though the state of California does not authorize LLLPs, the state does recognize LLLPs that were formed in other states.
Because LLLPs are not recognized in all states, this type of partnership structure is not a good choice if your business does business in multiple states. In addition, their liability protections have not been tested thoroughly in the courts.
Here is an article on the types of partnerships.
Image via Pexels by Tiger Lily
Business Partnership Structures
To legally form a partnership, there are a few steps involved.
The first step is to find the best partnership type for your situation through these steps:
- Research permitted partnerships in the state where you want to form the partnership . You can do this by checking the Secretary of State’s website to determine the types of partnerships available in your state and which ones are permitted for your business type.
- Discuss your vision and goals : What do you expect to contribute to the business, and what do you want to get out of it? Are you looking for steady income, a tax shelter, or the chance to pursue a dream? Do you have spouses or family members who might play a role in the business? How will you handle structuring money and partnership accounting?
- Based on all those factors, choose the structure that best fits your business.
Other steps involved are as follows:
- Draft a partnership agreement
- Name your business
- Register the partnership
- Submit annual reports
As all the steps can be daunting and overwhelming, consulting a legal and/or tax professional to assist may not be a bad idea.
Business Partnership Advantages
Following is a list of advantages of forming a business partnership.
- Bridging the gap in expertise and knowledge
- More Cash
- Cost Savings
- More business opportunities
- Better work/life balance
- Moral Support
- New Perspective
- Potential tax benefits
Partnering with someone can give you access to a wider range of expertise for different parts of your business. A good partner may also bring knowledge and experience you may be lacking, or complementary skills to help the business grow.
Partnership vs. LLC
A limited liability company (LLC) with two or more members (owners) is automatically treated as a partnership for income tax purposes unless it has elected to be taxed as a corporation. The main difference between an LLC and a partnership is that in an LLC, members are generally shielded from personal liability for the company. In many partnerships, only limited partners are protected from personal liability for the company.
Business Partnership Agreements
A strong business partnership agreement addresses how decision-making power will be allocated and how disputes will be resolved. It should answer all the “what if” questions about what happens in a number of typical situations.
For example, the agreement should spell out what happens when a person wants to leave the partnership or if a partner dies. If there is nothing in the partnership agreement that lays out how to handle the separation, state law will apply.
Get Help Forming a Business Partnership
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