By Jade Yeban, J.D. | Legally reviewed by Aviana Cooper, Esq. | Last reviewed October 16, 2023
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When entrepreneurs decide to start a new business, they face a big choice: what type of business structure to use. They can pick from structures like sole proprietorships, a limited liability company (LLC), or different types of partnerships.
This guide helps you understand partnerships and how they work.
A partnership is a type of business entity. In this type of entity, two or more business owners work together. Unlike a sole proprietor, where only one person runs the business, a partnership involves shared decision-making and business operations. Business activity happens under a chosen business name. All partners share the business debts and profits.
Partnerships have no formal paperwork requirements. So, partnerships are seen as “simple." However, partnerships usually don't protect partners from liability. This is a major distinction between partnerships and other types of business entities.
You may be surprised to learn that business partnerships do not have corporate tax status. Partnerships do not pay taxes as a business entity. What this means is that the Internal Revenue Service (IRS) doesn't have the power to tax them directly. Instead, the business income is divided among the partners. Partners then pay taxes on their personal tax returns using Schedule K IRS forms.
When a business partner files their personal income tax return, they will need to declare their operating losses and profits to the IRS in Form 1065. This is a way to avoid double taxation, where both the business and the individual get taxed. The government simply taxes the profits that flow to individual partners as personal income. To learn more about partnership taxes, visit FindLaw's Partnership Taxes page.
Planning ahead is key in partnerships. Also referred to as "business continuation agreements" or "buyout agreements," a buy-sell agreement is a contract. This contract 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.
A general partnership is the simplest business structure. Business owners have unlimited liability. This means that their personal assets might pay for business debts. Every partner has a say in day-to-day operations. They share in both profits and losses. But be careful! If one partner makes a mistake, all partners face personal liability for the actions of other partners.
Limited partnerships have two types of partners: general and limited partners. General partners manage the business and face unlimited liability. They handle the day-to-day operations of the business. Limited partners, in contrast, are silent partners. These silent partners invest money but do not manage day-to-day operations. They have limited liability, which protects their personal assets more than general partners.
A limited liability partnership (LLP) is popular among professionals like lawyers. This is because of malpractice concerns. In an LLP, all partners get liability protection. This means their personal assets have better protection from business debts and actions of other partners. They still share in the decision-making and business operations.
A limited liability limited partnership (LLLP) offers even more protection. While it's a newer business entity, it gives business owners the benefits of limited liability for all partners. In an LLLP, the partners avoid double taxation. Each state's secretary of state manages LLLP incorporation. State laws guide their operations.
Joint ventures are a special type of business partnership. They're formed when two or more businesses come together for a specific business activity or project. Unlike other partnerships, joint ventures have a set time frame. They are not always permanent. For instance, two companies might form a joint venture to develop a new product. Once the product is launched and the goal is achieved, the joint venture might end.
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 that 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.
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.
Speak to an experienced business lawyer about your partnership today.
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