What Is a Business Partnership?

A business partnership is a legal relationship usually formed by a written agreement between two or more individuals or companies. Partners invest their money in the business and each partner benefits from any profits and bears some of the losses.

A partnership as a business must generally be registered in all states in which it conducts business. Each state may have several different types of partnerships that you can form so it’s important to understand the possibilities before signing up.

How Does a Partnership Work?

Some partnerships include individuals working in the business while other partnerships may include partners with limited participation as well as limited liability for business debts and any lawsuits brought against the business.

In contrast to a corporation a partnership is not an entity separate from the individual owners. A partnership is similar to a sole proprietor or independent contractor business in that in both types of businesses the business is not separated from the owner for liability purposes.

Partnerships themselves do not pay income tax. After the profits or losses are distributed among the partners each partner pays income tax on his individual tax return.

Types of Partnerships

Before starting a partnership you need to determine the type of partnership you want. Usually three different types are set.

  • A general partnership (GP) consists of partners who are involved in the day-to-day operations of the partnership and are responsible for debts and litigation as owners.
  • A limited partnership (LP) has one or more general partners who manage the business and are responsible for their decisions and one or more limited partners who are not involved in the operation of the business and are not responsible.
  • A limited liability partnership (LLP) extends legal protection from liability to all partners including general partnersLLPs usually consist of partners in the same professional category such as accountants architects and lawyers. Partnership protects partners from liability actions of other partners. 8 9

Types of Partners in a Partnership

Partners may be individual companies and individual groups of companies. 1 Depending on the type of partner and the level of the partner hierarchy a partner can have different types of partners.

  • General and limited partners: General partners participate in managing the partnership and are generally responsible for the partnership’s debts and obligations. LPs invest but do not participate in management. 10
  • Different levels of partners: For example there may be junior and senior partners. These partnership types may have different responsibilities and input levels and investment requirements.

Partnership vs. LLC

A limited liability company (LLC) with two or more members (owners) is considered a partnership for income tax purposes. 11 The key difference between an LLC and a partnership is that in an LLC members are generally exempt from personal liability to the company. In many partnerships there are only limited Partners are exempt from the personal liability of the company.

Forming a Partnership

Partnerships are usually registered in one or more states in which they conduct business but registration requirements and the types of partnerships available vary from state to state. Partnerships use partnership agreements to clarify the relationship between partners; what to contribute Include the cash they will earn into the partnership; the partners’ roles and responsibilities; and each partner’s allocated share of profit or loss. 12 This agreement is usually only between partners; it is usually not registered in a state.

Check with your state secretary of state to determine the requirements for registering your partnership in your state. Some states allow different types of partnerships and partnerships in these partnerships.

Creating a Partnership Agreement

A strong partnership agreement deals with how decision-making power is distributed and disputes are resolved. It should answer all hypothetical questions about what would happen in many typical situations. For example it should explain what happens when a partner wants to leave. partnership. If the partnership agreement does not specify how separation or any other issue arises state law will apply.

A partnership agreement is best drawn up with the help of an experienced attorney.

Joining an Existing Partnership

Individuals can join a partnership after the partnership begins or operates. Newly joined partners must invest in the partnership bring funds (usually money) into the business and create a capital account. Investment amount and other factors such as amount The responsibilities a partner is willing to take determines the new partner’s annual investment and share of the business’ profits (and losses).

How Partners Are Paid

Partners are owners rather than employees so they usually don’t get a regular salary. Each partner receives an allotted share of corporate profits and losses each year. Payments are made under a partnership agreement and the partners are taxed separately on these payments.

Additionally some partners may receive guaranteed payments unrelated to their partnership share.This payment is typically used for services such as administrative duties.

How Partners Pay Income Tax

Income tax for the partnership is passed on to the partners and the partnership files an information return (Form 1065) with the IRS.Individual partners pay income tax on their share of the profits and losses of the partnership. Partners receive a Schedule K-1 showing their tax liability business from that year. Schedule K-1 is included in other income on the partner’s personal tax return

General partners must pay self-employment (SE) taxes (Social Security and Medicare taxes) on their share of partnership income. LPs must pay SE tax only on guaranteed payments.