Selecting a Business Partnership Type
Partnerships are a common option for people who want to go into business with other people. The term "partnership" has changed over the years, as business people have come to add new features to the old business form. The most used partnership types are listed here, with their features, to help you decide which type you might want to use.
What is a Partnership?
A partnership is a business with several individuals, each of whom owns part of the business. The partners may be active participants in running the business or they may be passive investors. The relationship between the partners, the percentage and type of ownership, and the duties of partners is clarified in the partnership agreement.
In any partnership, each partner must "buy in" or invest in the partnership. Usually, each partner's share of the partnership profits and losses is based on his or her percentage share of ownership.
Depending on the type and amount of participation in the business, partners may be liable for debts of the business and for lawsuits against themselves personally. The new partnership types created in the past few years are intended to help reduce liability issues with partnerships.
Partnerships are formed by states and are subject to state laws, so some partnership types may not be available in some states. Check with your state's business division (usually part of the secretary of state department) for partnership information.
A general partnership is a partnership with only general partners. Each general partner must actively participate in managing the business and any partner may sign a contract on behalf of the partnership. The partners must agree to major decisions, acting as a corporate board of directors.
Because general partners actively participate, they all must take personal responsibility for the liabilities of the business and for debts incurred by other partners. If one partner is sued, all partners are held liable. A partner's personal assets may be taken by a court or creditor. General partnerships are the least desirable for this reason.
A limited partnership includes both general partners and limited partners. In many cases, there is one general partner who manages the business and a number of limited partners. A limited partner does not participate in the day-to-day management of the partnership and his/her liability is limited to his investment in the business.
In many cases, the limited partners are merely investors who do not wish to participate in the partnership other than to provide capital and to receive a share of the profits. Because limited partners don't participate in management, they are considered passive investors. This means they can't take partnership losses off their income tax return if they don't have other income to offset it.
Considering Liability in Partnerships
The general partnership is similar to a sole proprietorship in the liability of owners. In both cases, the owner or owners have full liability for the debts of the business and for their actions. That's why new partnership types were set up to limit the liability of one partner for the actions of other partners. Limited liability in general means that the liability of any one partner is limited to that person's investment in the partnership.
In a limited partnership, limited partners have limited liability because they don't participate in management decision-making. General partners don't have limited liability because they are active in making decisions - and being liable for them.
Limited Liability Partnerships
A limited liability partnership (LLP) is different from a limited partnership or a general partnership but is closer to a limited liability company (LLC). In the LLP, all partners have limited liability. LLP's are often formed by groups of professionals who want to pool their resources and save money by sharing space.
An LLP combines characteristics of partnerships and corporations. As in a corporation, all partners in an LLP have limited liability, from errors, omissions, negligence, incompetence, or malpractice committed by other partners or by employees. Of course, any partners involved in wrongful or negligent acts are still personally liable, but other partners are protected from liability for those acts.
LLC or Partnership?
In recent years, the limited liability company has become more common than the general partnership and the limited partnership, because it has more limited liability for the owners (as the name suggests).
But there are still cases in professional practices in which some partners want to be limited in the scope of duties and they just want to invest, having the liability protection of being in a limited partnership.
You might have also considered setting up your multiple-person business as an LLC. While a multiple-member (owner) LLC is taxed like a partnership, there are differences in liability and in other ownership provisions. The main difference is that all owners of an LLC (called "members") have limited liability, even if they participate in running the business, while in a partnership the partners running the business have general liability for everything that happens.
Joint Ventures as Partnerships
The Small Business Administration lists a joint venture as a type of partnership. A joint venture is typically a partnership between different businesses formed for a specific purpose (like making a movie or building a structure) or for a specified time period.
Qualified Joint Ventures as Partnerships
A qualified joint venture is a special kind of partnership in which two spouses who jointly own a business can elect to file their income taxes separately to avoid having a file a complicated partnership tax return. in this case, each spouse files a Schedule C for his or her share of the net income of the business. If the couple is filing jointly, both Schedule C's are included in the joint tax return. You can read more about how a qualified joint venture works, and the restrictions.
Types of Partners
Just to confuse the issue, a partnership can have different types of partners - general partners and limited partners. There can be both types of partners in any type of partnership except for the general partnership, which has only general partners. Briefly, the two types of partners:
- General partners, who invest in the partnership, participate in the day-to-day operations and are liable for debts and lawsuits of the partnership
- Limited partners, who invest in the partnership but who have no participation in day-to-day operations and who are not usually considered to have liability.
Partnerships and Tax Issues
As you are considering partnership type, you should also consider how a partnership (and a multiple-member LLC) is taxed. The partnership, as a whole, files an information return on Form 1065 and the individual partners receive a Schedule K-1 showing the share of the partnership profits or losses for the year. The Schedule K-1 is included in each partner's personal tax return, so each partner pays income tax on their share of the net income of the partnership.
Read more about how a partnership pays income taxes.
This is a general overview of these partnership types. This article describes the steps to starting a partnership.