Partnership
Typically, partnerships can be placed into two categories—general partnerships and limited partnerships. One of the advantages these entities have is that they pay no tax at the partnership level. Instead, all profits and losses are passed through to the partners according to their percentage of ownership (in the absence of a special allocation), even if the profits remain in the business to fund continuing operation or expansion. Beyond this basic principle, partnership tax law is a complex subject to understand and is fraught with traps for the unwary.
Partnership Tax Returns: Make certain to
Consult with a tax professional who is familiar with partnership taxation when forming your partnership and filing the partnership tax return.
A general partnership involves two or more people carrying on a business together and sharing the profits and losses. Unless limited by the partnership agreement, each partner has full managerial control over the partnership. In addition, each partner has unlimited personal liability for the debts and obligations of the partnership.
To form a general partnership, prepare a written partnership agreement to set forth the ownership and responsibilities of the partners. If you require money to fund operations or expand the business, the general partnership can take on new general partners by selling a new partnership interest. Unless otherwise stated, any new partners will have the same rights, responsibilities, and liabilities of the original partners.
Advantages. Partners can combine their expertise and assets for a common goal. Most states do not usually require general partnerships to file organizational documents, unless there is fictitious name filing required. The following states, however, require the filing of a Statement of Partnership Authority or similar form for general partnerships.
• California
• Delaware
• District of Columbia
• Hawaii
• Idaho
• Kansas
• Oklahoma
• South Dakota
• Virginia
In addition, a handful of states require the filing of initial and continuing annual reports. General partnerships have higher maintenance costs than a sole proprietorship because they must track assets and liabilities as well as income and expenses. However, they have lower maintenance costs than a corporation because they are not required to have the same governance formalities as corporations. In addition, the business can continue after the disability or death of a partner if there are more than two partners. Partnerships file their federal income tax returns on Form 1065. State income tax filings may also be required, depending on the state in which the partnership is domiciled (the state of legal residence).
Disadvantages. A general partnership is potentially a dangerous form of business entity because each partner is jointly and severally liable (meaning together and separately liable) for the debts of the partnership and the acts of other partners within the scope of the business. Thus, if your partner breaches a contract or signs a million dollar credit line in the partnership name, you can be personally liable. All parties share control, and the death of a partner may result in the liquidation of the partnership. It is often hard to get rid of a disgruntled partner.
A carefully drafted partnership agreement prepared by an attorney can mitigate the disadvantages inherent in partnerships.
A limited partnership has characteristics similar to both a corporation and a partnership. The general partners have control and unlimited personal liability, but the limited partners, who put up money, have their liability limited to the amount of their capital contribution to the partnership (like corporate stock). A limited partnership must have at least one general partner and one or more limited partners.
Advantages. A limited partnership usually only needs to file a one - page document, called a Certificate of Limited Partnership, with the state upon formation and pay a fee. In a handful of states, however, the limited partnership is also required to file an initial report and continuing annual reports with the state to update the contact information for the partnership, resident agent, general partners, and in some cases, the limited partners. Capital can be contributed by limited partners who have no control over the business and no liability for its debts or obligations.
A limited partnership may define the term of its existence in its partnership agreement. In addition, the business can continue to operate after the death or disability of a general partner if appropriate survival language is included in the limited partnership agreement.
Just like general partnerships, limited partnerships have higher maintenance costs than a sole proprietorship because they must track assets and liabilities as well as income and expenses. They have lower maintenance costs than a corporation, because they are generally not required to pay taxes (although they must file tax returns on Form 1065) and are not required to hold meetings or keep minutes like a corporation.
Disadvantages. Like a general partnership, your attorney should prepare a limited partnership agreement to set forth the ownership and sharing arrangements of the partners. In a limited partnership, the general partner is personally liable for partnership debts and for the business-related acts of other general partners.
QUICK Tip
Limiting Liability: To limit the general partner's liability, use a corporation or LLC as the general partner.
Limited partners give up most of their control over the business in exchange for limited liability. When limited partners take an active role in the running of the business, they jeopardize their protection from liability and can be held liable as a general partner. Assuming limited partners take no part in management, they enjoy limited liability as in a corporation. Like general partnerships, limited partnerships are subject to the same complex tax rules, so consult with a tax professional familiar with partnership taxation when forming your limited partnership.
In recent years, the limited liability company has overtaken the limited partnership as the tax-advantaged vehicle of choice, because everyone involved has limited liability and investors can participate in the decisions of the company.
