A Partnership is a legal entity where two (or more) people run a business. It is the simplest structure for operating a business with multiple owners. The owners (“partners”) of a Partnership share legal, financial, and management responsibilities for the company.
Highlights of utilizing a Partnerships:
- There is no limit to the number of partners a GP may have.
- Owners of a General Partnership are not considered employees of the company.
- Similar to a Sole Proprietorship, a Partnership is considered to be the same legal and tax-paying entity as its owners.
- All partners are personally liable for the legal and financial debts of the business. So, if a Partnership runs into legal or money troubles, the owners’ personal assets are at risk of being taken to settle those obligations.
- Owners typically get paid by taking owner draws (withdrawing funds out of their business for personal use).
- Partnerships are “pass-through” entities for income tax purposes. Business profits and losses flow through to the partners’ personal tax returns. All of the profits are also subject to self-employment taxes (Medicare and Social Security) because partners are not on the company payroll and do not receive paychecks with Medicare and Social Security taxes deducted from them. Usually, partners must make quarterly estimated tax payments to the IRS, state, and local tax authorities
- Although Partnerships don’t pay tax, they must file an annual information return (Schedule K-1, IRS Form 1065) with the IRS to report the income, deductions, gains, losses, etc. from their operations. Each partner then uses information from that form to report their share of the partnership’s income or loss on their individual tax returns.
Advantages and Disadvantages of Partnerships
Advantages
- Easy to start, since there is no need to register your business with the state.
- No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
- You don’t need to absorb all the business losses on your own because the partners divide the profits and losses.
- U.S. citizens, LLCs, corporations, and foreign individuals or entities may form a General Partnership by agreeing to do business in the U.S. with another party.
- Owners can deduct most business losses on their personal tax returns.
Disadvantages
- Each owner is personally liable for the business’s debts and other liabilities. In fact, the actions of one partner could impose liability on the personal assets of another partner.
- In some states, each partner may be personally liable for another partner’s negligent actions or behavior (known as “joint and several liability”).
- Disputes among partners can unravel the business, though drafting a detailed Partnership Agreement can help you avoid this.
- It’s more challenging to get a business loan, land a big client, and build business credit without a registered business entity.
Starting a Partnership
A Partnership is not a formal business entity like a Limited Liability Company or C Corporation. Usually, there is no business registration paperwork required by the state when entrepreneurs want to establish a GP. As soon as the owners begin to conduct business together, the partnership is established.
Creating the Partnership Agreement is the most important step. It will lay out the relationship between the parties.
Some things included in a basic Partnership Agreement:
- Business Name – More important here than in a sole proprietorship because partners will often share business accounts and act in the name of the business.
- Contributions – Each partner’s stake in the formation and ongoing finances of the business must be clearly laid out. How much will each put into the pot? What about future obligations?
- Distributions – How will profits be split between partners? Who gets paid first and how much?
- Ownership – Who gets what if the business is sold? What happens if one partner wants to withdraw? What about taking on new partners? What are the options for buying out another partner?
- Decision Making – Who gets the last say? What about day-to-day management decisions?
- Managing Disputes – How will disputes be handled? Is binding arbitration a good option or will things have to go to court? Does a ‘silent partner’ have a say in business operations?
- Critical Changes and Developments – What happens if one partner gets sick or dies? How will the business be evaluated (and what is the split) if a buy-out offer comes in? What provisions will be used for retirement? Under what circumstances can the partnership agreement be modified, and how?
These are the most common issues. You should see immediately one of the downsides of a Partnership – a substantial difference of opinion between partners. What starts out as a wonderful relationship can change into a phenomenal burden over time and under the stress of doing business.
The best recommendation is to get help when drawing up a Partnership Agreement. Make sure each party fully understands the conditions and the document include as much detail as possible. It is a wise practice to consult an attorney to ‘vet’ the agreement and point out weaknesses.
When a DBA is Needed
When a General Partnership’s owners do not want to include all of the partners’ last names in the business name, they must request to use a tradename. To do so, they need to file a DBA (“doing business as,” also known as a “fictitious name” filing). The DBA must be filed with the state or the county clerk—depending on the business’s location.
For example, if Janice Smith and James Jones want to market their new business by the name “Texas Taco Shack,” they would need to file a DBA for that name with the state or county clerk’s office. Many states also require that businesses have their fictitious name published in one or more approved newspapers or other publications in the county where it was filed.
Fictitious names may need to be renewed, so it’s important to verify the county and state requirements.
Keep in mind that registering a DBA does not provide any legal protection for the company name. Its purpose is to disclose the individual, people, or entity operating the company under the assumed name to the public. This helps protect potential customers, vendors, and others from doing business with unscrupulous owners attempting to hide their real identities. If a Partnership wants to obtain exclusive rights to use its DBA, it must register it as a trademark through the USPTO (U.S. Patent and Trademark Office).