Understanding the Basics of a Partnership

A partnership is a business with more than one owner that has not filed papers with the state to become a corporation or limited liability company (LLC). There are two types of partnerships – general partnerships and limited partnerships. Today we will only discuss general partnerships – those in which every parent has a hand in the management of the business.

The partnership is the simplest and least expensive co-owned business structure to create and maintain. However, there a few important facts you should know before you begin.

Personal liability for all owners

Partners are personally liable for all business debts and obligations, including court judgments. This means that if the business itself cannot pay a creditor, such as a supplier, a lender or a landlord, the creditor can legally come after any partner’s house, car, or other possessions.

Any individual partner can bind the whole business to a contract or other business deal. For example, if your partner signs a one-year contract with a supplier to buy inventory at a price your business cannot afford, you can be held responsible for the money owed under the contract.

Also, each individual partner can be sued for and be required to pay the full amount of any business debt. If this happens, an individual partners’ only recourse may be to sue the other partners for their shares of the debt.

Because of this combination of personal liability for all partnership debt and the authority of each partner to bind the partnership, it is critical that you trust the people with whom you start your business.

Partnership taxes

A partnership is not a separate tax entity from its owners, it is a “pass-through entity”. This means that the partnership does not pay any income taxes on profits. Business income simply “passes through” the business to each partner, who reports his share of profit—or his losses—on his individual income tax return. In addition, each partner must make quarterly estimated tax payments to the IRS each year.

Creating a partnership

You do not have to file any paperwork to establish a partnership – you can simply agree to go into business with someone and get started.

Partnerships do need to fulfill the same local registration requirements like any business including applying for a business license. Most cities require businesses to register with them and pay at least a minimum tax. You may also have to obtain an employer identification number from the IRS, a seller’s permit from your state and a zoning permit from your local planning board.

While the owners of a partnership are not legally required to have a written partnership agreement, it makes good sense to put the details of ownership, including the partners’ rights and responsibilities and their share of profits, into a written agreement.

How Partners are Paid

Partners are owners, not employees, so they do not generally get a regular paycheck. Each partner receives a distributive share of the profits and losses of the business each year. Payments are made based on the partnership agreement, and the partners are taxed individually on these payments.

Terminating a partnership

The partnership dissolves when one partner wants to leave the company. In that case, the partners must fulfill any remaining business obligations, pay off all debts, and divide any assets and profits among themselves.

The Partnership Agreement

It is easy to set up a partnership because there are no legal documents to file. According to the SBA, your partnership agreement should include the following:

  • Amount of equity invested by each partner
  • Business type
  • How profits and losses will be shared
  • Decision-making policies
  • Pay and bonuses (if any)
  • Distribution of assets
  • Provisions for changes in the partnership
  • Settlement of business in case of death
  • Restrictions regarding authority and expenditures
  • Expected length of the partnership

The Bottom Line

It is worth considering creating a business partnership when you find someone who complements your skills and know that he or she will add value to your business. These partnerships can be lucrative and fun if the foundation is set up right from the beginning.