Small Business Tutorial - Partnerships

A partnership, like a sole proprietorship, is not a legal entity separate from the business. Under state law, should you and at least one other person carry on business activities with the intention of making a profit, that business is automatically considered to be a partnership. For more information on partnership legislation see subsection on State Laws below. There are also two types of partnerships, a general partnership and limited partnership. For information specific to limited partnerships see the subsection on Limited Partnership below.

Advantages of Partnerships: Like a sole proprietorship, a partnership can be easy and inexpensive. In addition to the simplicity and low cost of operating a partnership, your share of the partnership business losses are deductible from your personal income and, if your income is small, the tax you pay on your share of partnership income will be low.

Disadvantages of Partnerships: Under state law 1) your share of the partnership assets is part of your personal assets 2) any partnership liabilities or losses are considered to be personal liabilities of the individual partners (i.e. you could be forced to pay partnership debts out of your personal, non-business assets and 3) your share of partnership income is taxed as part of your personal income and, if the partnership did very well and taxable income, including your partnership share, was higher than approximately an amount determined by the Internal Revenue Service, tax on income over that amount would be paid at the highest personal rate.

State Laws on Partnership: As stated above, should you and at least one other person carry on business activities with the intention of making a profit, that business is automatically considered to be a partnership governed by state laws. The terms of the partnership will include some, if not all, of the following rules:

• All partners have an equal say in management of the partnership, an equal share of partnership income and an equal share of partnership assets and an equal share in the liabilities and debts of the partnership
• The partnership automatically dissolves if one partner dies, goes bankrupt or withdraws from the partnership
• A new partner can be admitted only with the consent of all existing partners
• Each partner is liable for any wrongful act or omission of any other partner in the course of business
• The partnership must repay any partner who incurs liability on behalf of the partnership in the course of business
• If any partner contracts with a thirty party, all members of the partnership are responsible for that contract
• If the partnership has any debt any of the partners can be required to pay it
• Partners may not compete with the partnership

If these rules do not reflect the way you wish for your partnership to function, you must enter into a partnership agreement with your partner(s) to specify the way in which the partnership will carry on business. Partnership agreements as provided by our consulting lawyers can be found in the Forms Store. [Note: a partnership agreement cannot be used to override rules concerning liability of the partners and the partnership to third parties.] At a minimum, a good partnership agreement should deal with the following issues:

• The nature of the business and the firm name
  
• Financial contributions by each partner
  
• A definition of what constitutes partnership income (before/after debt)
  
• Division of work among partners
  
• Bank accounts, accounting and tax matters
  
• Insuring assets
  
• Insuring partners (life and disability)
  
• Disability/death/incapacity of a partner
  
• Use of partnership property by individual partners
  
• Methods to resolve disputes among partners

Partnership Agreement

For example, your partnership may not divide profits equally but may take into account monies generated by each partner, accounts or the client base generated by each partner, or rainmaking activities done on behalf of the partnership. The agreement might also outline rules for partner draws against their share of the profits or unequal division of partnership assets because each partner contributed assets of differing value. It could provide some partners with more rights to make management decisions or give each partner the right to force another partner to sell his/her interest or to buy out his/her interest (a buy-sell clause).

It is also a good idea to schedule and record regular partnership meetings which review important matters such as new clients, rainmaking, competition, projected income and expenses, distribution of work among partners and other administrative or office management issues.

Partnership Agreement

REGISTERING A PARTNERSHIP

Registering a partnership is a relatively easy process in any state.  Check with your local companies office for instructions on registering a partnership.

Limited Partnership: A limited partnership is like a general partnership except it has general partners and limited partners. A limited partner contributes money to the partnership but does not participate in management of the business. A limited partners' liability is limited to the amount of their investment in the partnership. Limited partnerships are commonly used for tax shelters by giving the limited partners the tax benefit of loss deductions associated with ordinary partnerships, as well as the same protection against liability that a corporation provides for a shareholder.