By definition, a partnership is a business with more than one owner that has not filed papers with the state to become a corporation or LLC (limited liability company). There are two basic types of partnerships—general partnerships and limited partnerships. This article discusses only general partnerships—those in which every partner 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
First, partners are personally liable for all business debts and obligations, including court judgments. This means that if the business itself can’t 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.
Second, any individual partner can usually bind the whole business to a contract or other business deal. For instance, if your partner signs a year-long contract with a supplier to buy inventory at a price your business can’t afford, you can be held personally responsible for the sum of money owed under the contract.
There are just a few limits on a partner’s ability to commit the partnership to a deal—for instance, one partner can’t bind the partnership to a sale of all of the partnership’s assets—but generally, unless an outsider has reason to know of any limits the partners have placed on each other’s authority in their partnership agreement, any partner can bind the others to a deal.
Third, each individual partner can be sued for—and be required to pay—the full amount of any business debt. If this happens, an individual partner’s 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’s critical that you trust the people with whom you start your business.
A partnership is not a separate tax entity from its owners; instead it’s what the IRS calls a “pass-through entity.” This means the partnership itself 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.
While the partnership doesn’t pay taxes, it must file Form 1065, an informational return, with the IRS each year. This form sets out each partner’s share of the partnership profits (or losses), which the IRS reviews to make sure the partners are reporting their income correctly. For more information on reporting and paying partnership taxes, see How partnerships are taxed.
Creating a partnership
You don’t have to file any paperwork to establish a partnership—just agreeing to go into business with another person will get you started.
Of course, partnerships must fulfill the same local registration requirements as any new business, such as applying for a business license (also known as a tax registration certificate) 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.
In addition, your partnership may have to register a fictitious or assumed business name. If your business name doesn’t contain all of the partners’ last names, as in London Landscapes, you usually must register that name—known as a fictitious business name—with your county.
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. For more about why partnership agreements are so important, read Creating a partnership agreement.
Ending a partnership
One disadvantage of partnerships is that when one partner wants to leave the company, the partnership generally dissolves. In that case, the partners must fulfill any remaining business obligations, pay off all debts, and divide any assets and profits among themselves.
If you want to prevent this kind of ending for your business, you should create a “buy-sell agreement,” which can be included as part of your partnership agreement. A buy-sell agreement helps partners decide and plan for what will happen when one partner retires, dies, becomes disabled or leaves the partnership to pursue other interests. One way a buy-sell agreement helps avoid this situation is by allowing the partners to buy out a departing partner’s interest so business can continue as usual. See Plan for ownership changes with a buy-sell agreement for more information.