Partnerships: What You Need to Know

General Partnerships

A general partnership is an informal type of business structure and exists when two or more people come together for the purpose of conducting business. If you are part of a general partnership, you do not have a company to hide behind. All of the business’s debts and obligations belong to each partner as individuals. If one partner makes a decision that puts the company in debt, all of the other partners are equally responsible for that debt. However, that individual liability can be an advantage come tax season. Profits from the general partnership are not taxed to a company; rather, they are passed through to the partners, who can claim the profits on their individual returns.

Limited Partnerships

Limited partnerships afford more protection to each of the partners involved. A limited partner is only liable up to the amount that he or she has invested into the business. One partner must be designated the general partner, and that person alone will bear the personal liability on behalf of the business. However, the general partner also holds decision-making power over the business while the other limited partners do not. Profits and losses are passed through to both the general and limited partners for tax purposes.

Limited Liability Partnerships

With a limited liability partnership, sometimes called an LLP, each of the partners’ personal liability is limited. The partners in an LLP are not responsible for each other’s debts and obligations, making it an attractive structure for professionals such as doctors, accountants and lawyers. While the partners may pass through profits from the LLP on their federal tax returns, some states prohibit that practice.

Downsides to a Partnership

While partnerships are easy to form and allow for a great degree of flexibility, there are some distinct disadvantages compared to other types of corporate structures. One of the biggest drawbacks is the exposure to personal liability. If the partnership gets sued for an outstanding debt, your personal assets such as your house, your car and your savings may be at risk. Along those lines, another downside is that in some instances a partner can unilaterally make business decisions that affect the other partners. In addition, should one of the partners pass away suddenly or decide to walk away from the business, the partnership is considered dissolved, and the other partners lose out on a potentially successful business. Also, one partner’s stake in the business cannot be transferred to another person unless each of the remaining partners consent to it. This means that even if you have a disagreement with one of your partners, you may be stuck working with them.

The Importance of Having a Partnership Agreement

If you enter into a partnership, having a partnership agreement in place from the outset can help provide clarity and prevent future problems from arising. A partnership agreement is a place where you can put in writing what each partner will contribute to the business and how profits and losses will be allocated among the partners. You can also designate which of the partners will have authority to make decisions on behalf of the business, enter into agreements or contracts on behalf of the other partners and manage the business’s finances. Your partnership agreement can also outline the terms for adding additional partners to the business or how it will be handled when a person exits the partnership. By having all of these issues decided in writing before you start to do business, disputes can be avoided. A partnership agreement gives you a degree of control over your business because if you do not have one in place, your partnership will be subject to whatever the default rules for partnerships are in your state.Entering into a partnership can be an easy way to get a business off the ground. A partnership allows its owners to have great flexibility and the freedom to run their business as they see fit. Understanding what a partnership does and does not provide can help you be confident that you are choosing the right structure for your business.