Partnerships are the simplest type of legal structure to form for businesses with two or more principles; but while partnerships have no formal paperwork requirements, they usually don't protect partners from liability. Partners can also clash over numerous matters relating to the business, including conflicting work ethics and financial goals, and even roles in the business and leadership styles. Here you will find tips on legal and tax issues related to partnerships and a "Partnership QuickStart" tool that walks you through each phase of the start-up process.
You may be surprised to learn that business partnerships do not have corporate tax status. What this means is that the Internal Revenue Service (IRS) doesn't have the power to tax them directly. Conversely, the government simply taxes the profits that flow to individual partners as personal income. When a business partner files his or her personal income tax return, he or she will need to declare their operating losses and profits to the IRS in Form 1065.
Buy Sell Agreements: Planning for the Future
Also referred to as "business continuation agreements" or "buyout agreements," a buy-sell agreement is a contract that provides for the possible future sale of your business interest or purchasing your co-owner's interest. One reason partners tend to enter into a buy-sell agreement is due to concerns about the health of one partner. If a co-partner dies, it will affect the operation of the business. A fully-funded buy-sell agreement can help eliminate any doubts about the future of your company.
Limited Partnerships: The Basics
There are three types of partnerships that businesses can choose from when forming a partnership: general, limited or joint venture. While there are benefits and disadvantages to all three, in a limited partnership at least one owner is a general partner and at least one owner is a limited partner. The general partner(s) makes everyday business decisions and becomes personally liable for any debts the business incurs. The limited partner, however, doesn't handle daily operations, but simply invests and reaps the benefits of any profits. Basically, a limited partner enjoys a protected investment.
In a normal business arrangement, income, gains, losses, deductions, and credits are distributed according to each partner's or member's ownership percentage. However, when the partners set up a "special allocation," income and expenses are redistributed according to the allocation or agreement. Keep in mind, IRS rules must be followed if you want to divide profits and losses in a way that's disproportionate to the owners' interests in the business.
Hiring a Business Lawyer for your Partnership
Unfortunately, partnership rules and regulations can be extremely complicated. If you want to set up a special allocation, you'll need expert help to make sure that your allocation will comply with IRS rules. A business lawyer can draft special language for your partnership agreement or operating agreement to ensure that the IRS will accept your special allocation. An attorney specializing in partnerships can help you formulate your buy sell agreement and even help reduce your tax liability for the future.