A partnership is a form of business where two or more people share ownership, as well as the responsibility for managing the company and the income or losses the business generates. That income is paid to partners, who then claim it on their personal tax returns – the business is not taxed separately, as corporations are, on its profits or losses.
In the United States, partnerships enjoy a greater amount of flexibility. It is quite easy to raise more capital by bringing more people into the business. Partnership can be a wonderful way of combining different skills and shared experience to create a powerful business entity.
In a partnership, you don’t have to pay corporation or capital gains tax. The costs of incorporating a company are avoided and there is less administration due to no requirements to file documents with Companies House (apart from LLPs). Partnerships do not have to publish or audit their accounts which means that financial and other information can be kept private (apart from LLPs).
However, note that you and your partners are personally responsible if the business makes a loss (apart from limited partners and in the case of LLPs). Your share of profit is taxed as income. Also, any dispute that arises in a partnership can cause huge problems for the business especially when it comes to ending the business.
Partnerships are more or less registered with the state or states in which they do business, but the requirement to register and the types of partnerships available tend to vary from state to state. Partnerships also make use of a partnership agreement to clarify the relationship between the partners; what contributions, including cash, they will make to the partnership; the roles and responsibilities of the partners; and each partner’s distributive share in profits and losses.
This is normally an agreement between the partners; it is not generally registered with a state. However, a strong partnership agreement addresses how decision – making power will be allocated and how disputes will be resolved. It also answers all the “what if” questions about what happens in a number of typical situations. Note that state law will apply if there is nothing in the partnership agreement that lays out how to handle the separation—or any other issue that arises.
In addition, partners are owners and not employees, so they don’t normally receive a regular pay check. Instead, each partner receives a distributive share of the profits and losses of the business each year. Payments are made based on the partnership agreement, and the partners are taxed individually on these payments. Note that some partners may receive a guaranteed payment which isn’t tied to their partnership share. This payment is usually for services like management duties.
Howbeit, do not forget to check with your state’s secretary of state to determine the requirements for registering your partnership in your state. Some states allow different types of partnerships and partners within those partnerships.
Different Types of Partnership Entity are Their Pros and Cons
Before you start a partnership, you will need to decide what type of Partnership entity you want. There are three different kinds that are commonly set up.
1. General Partnership
A general partnership is the most basic form of a partnership. In the United States, it is defined as the association of people or an unincorporated company. This type of partnership entity must be formed by agreement, estoppel, and proof of existence. It requires a minimum of two people and all partners have an equal share in the liability and responsibility of the business.
Also note that in this type of partnership, each partner is taxed on their personal income tax return instead of a business tax return. It also entails that all business income must be included on the returns. Then partners can deduct losses from the business on their own returns. However, here are some of the key pros and cons of a general partnership.
Pros
- They are usually easier to form
- Pass – through tax treatments are available with a general partnership.
- There are no tax withholding requirements for partners
- There is an equal right to manage the business within a general partnership
- The structure can be converted to other business types
- It is a default business entity
- It allows multiple people to come together to start a company
- Limited partnerships are possible in some region
- More than one person can be involved in fundraising efforts
Cons
- Disputes can limit the growth of the business
- General partnerships are exposed to the self – employment tax.
- General partners are deemed to be agents.
- Personal assets are at – risk within a general partnership
- Liabilities in a general partnership are unlimited
- Many general partnerships suffer from instability
- It can be difficult to raise money in a general partnership
- Most of the time, partners are not allowed to transfer their interest in the business
- You must be licensed before doing business in many states
- Some partnerships can be terminated even though the business is successful
- There may be business taxes to pay from personal finances
- Guaranteed payments are considered net earnings
2. Limited Partnership
When a business is established as a limited partnership, then there are at least two partners who are both in charge of the business. A general partner is liable for the debts and obligations incurred by the company.
A limited partner invests a certain sum of money in the business as capital and cannot be held liable for the debts incurred by the company beyond the amount he contributes. Although a limited partnership is a rather easy and cost – effective business structure to form, there are certain pros and cons that must be considered.
Pros
- Limited partners are protected from high levels of liability
- There are very simple and flexible
- Limited partnership shares are considered securities
- Any business costs can be directly deducted from personal income.
- Turnover issues don’t have to become issues
- Growth is ultimately scalable
Cons
- The business typically needs to be registered with a business registration office
- Limited partners have no voting power.
- Profits are treated as personal income.
- General partners in a limited partnership are personally reliable for business debts
- General partners carry all of the risk.
- Fundraising can be extremely difficult.
3. Limited Liability Partnership
This is where some or all the partners will have limited liabilities, depending on the jurisdiction. Howbeit, it exhibits elements of corporations and partnerships. For this reason, a partner should not be liable or responsible for the negligence or misconduct of another partner. Nonetheless, there are certain pros and cons of limited liability partnerships (LLP).
Pros
- Separation of Legal Entity
- Enjoys Tax Benefits
- Liability Depending on Investment
Cons
- One General Partner
- More Documentation Required
- Self – Employment Taxes to Pay
- Regular Meetings and Documents to Comply
Different Types of Business Partners in a Partnership Entity (Pros and Cons)
A partnership is a unique type of business. It is made up of at least two owners, but it could have many owners (thousands, even). Also note that these owners share in the benefits and drawbacks of the business partnership, according to the terms of a partnership agreement that they sign when they join the partnership.
In the United States, the different types of partners in a partnership are similar because they all have made an ownership contribution. Partner types are different in how active they are in the partnership and how much liability they have. However, depending on the type of partnership and the levels of partnership hierarchy, a partnership can have different types of partners: General partners and limited partners.
1. General Partner (Active Partner)
A general partner in a partnership takes part in the daily operations of the partnership and is personally responsible for the liabilities of the partnership. This active partner, also known as a working investor works in the business partnership, helping with day – to – day management.
Pros
- Steady income
- Less interference from a silent partner
- Control over investments
- Enjoys Tax Benefits
- Right to manage the business
Cons
- Personal assets are at – risk
- Self – Employment Taxes to Pay
- Carry all of the risk
- Time consuming
2. Limited Partner (Silent Partner)
The presence of a silent partner in the business has multi – fold contributions but he does not directly participate in the managerial functions of the partnership business. Note that a limited or silent partner does not have the authority to perform acts on behalf of the organisation and enter into contracts with third parties. Although there are several key benefits for having a silent partner on board, there are certain drawbacks as well that you should consider before you enter a partnership.
Pros
- Limited Liability
- Easy Investments
- Less Responsibility for a Silent Investor
- Passive Income for the Silent Partner
- Access to Networks
Cons
- Have no official input into the profit models
- Cannot actively position the company’s finances to maximize its valuation
- Know nothing about the standards in every department of the business
- No voting power
Also note there may be other levels of partners in a partnership. Levels of partners in the partnership may be senior partners, junior partners, and associate partners. Duties and responsibilities also tend to differ at different levels. At each level comes more responsibility, including the training and supervision of lower – level partners. Some partners may be responsible just for administration while others focus on gaining and maintaining clients.
Conclusion
To form a partnership in the United States, all you need is to register the partnership in the state where it is going to do business, and to create a partnership agreement defining what each partner is responsible for, the different types of partners, how partner ownership works, and how to handle changes in the partnership. Always remember that partnerships are formed and operated under state regulations.