Types of Partnerships

When you're thinking about starting a small business, choosing the right business structure is crucial. This decision can impact your income tax, the paperwork you need to file, and your level of risk. A partnership arises whenever two or more people co-own a business and share in the profits and losses of the business. Other business legal structures include sole proprietorships, limited liability companies (LLCs), corporations, and nonprofit corporations.

In a partnership, each person contributes something to the business. This can be ideas, money, property, or some combination of these. Management rights, profit share, and personal liability will vary. These factors depend on which type of partnership the business takes. These forms include general partnership, limited partnership, or limited liability partnership (LLP). Below are basic summaries of the main types of business partnerships.

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General Partnerships

A general partnership involves two or more owners carrying out a business purpose. General partners share equal rights in connection with the management of the business. They also share equal responsibility. Any individual partner can bind the entire group to a legal obligation.

Each individual partner assumes full responsibility for all the business's debts and obligations. This is sometimes called unlimited liability. This means a business owner's personal assets can be used to settle business debts. Such personal liability can be daunting, but it comes with a tax advantage.

Partnership profits are not taxed to the business but pass through to the partners. This includes the gains on their individual tax returns at a lower rate. Each partner files a personal income tax return, and they don't face double taxation.

This type of business structure is easy to start. You don't need to file an article of incorporation with the secretary of state. To start, decide on a business name, get a business license (if needed), and open a bank account for your business.

Limited Partnerships

A limited partnership is a partnership with two different types of business owners. These types include a general partner and a limited partner. General partners manage the business and face unlimited liability. Limited partners invest money but have limited decision-making power.

A limited partnership allows each partner to restrict their liability, which depends on the amount of their initial business investment. Not every partner benefits from this limitation. At least one participant must accept general partnership status. This exposes them to full personal liability for the business's debts and obligations. The general partner retains the right to control the business. The limited partner(s) do not take part in management decisions. Both general and limited partners enjoy business profits.

The Internal Revenue Service (IRS) sees limited partnerships as separate entities, so it has its tax status. Business taxes get passed to individual partners. There is no double taxation. This form of business is common for professional services and startups.

Limited Liability Partnerships (LLP)

Limited liability partnerships (LLPs) are like limited partnerships, but they give some liability protection to all partners. LLPs keep the tax advantages of the general partnership form. At the same time, they offer some personal liability protection to the participants. In an LLP, business owners have protection against business debts. They're still responsible for their actions. 

Individual partners in an LLP are not personally responsible for the wrongful acts of other partners. They are also not responsible for the debts or obligations of the business. This is a favorite choice for professional services, like lawyers or doctors.

The LLP form changes some of the fundamental aspects of the traditional partnership. As a result, some state tax authorities subject LLPs to non-partnership tax rules. The IRS views these businesses as partnerships. They allow partners to use the pass-through technique for taxation.

Partners in LLPs report their earnings on personal tax returns. This helps avoid the issue of double taxation.

Existing partnerships that wish to change to LLP status do not need to change their existing partnership agreement, but they might choose to do so. To change status, a partnership simply files an application for registration as an LLP with the appropriate state agency. 

All states need disclosure of the partnership's name and principal place of business. Some states also require, among other things, identification of the number of partners. They might want a brief description of the business and a statement that the partnership will maintain insurance. They might also ask for written acknowledgment that the limited liability status may expire.

To form an LLP, entrepreneurs need to file specific documents with the secretary of state to register their business entity. While it offers more protection than a general partnership, it's not a complete shield like a limited liability company (LLC). To learn more about the difference between an LLC and an LLP, visit FindLaw's LLCs vs. LLPs page.

Get Legal Help Before Setting up Your Partnership

Starting a business is exciting, but it's essential to get it right from the beginning. From choosing your legal entity to understanding your tax-exempt status, there's a lot to consider. With so many different types of business entities and types of corporations, always consult with professionals before making decisions.

If you're interested in learning more about the different types of partnerships, talk to a skilled attorney. An attorney can help you navigate the world of business entities. They can help you with business formation for your new business. This can help protect your business from issues in the future.

Speak to a skilled business attorney near you.