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.
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.
Two Types of Partners
The best way to start talking about a partnership business is to talk about the two types of partners: general partners and limited partners. Both invest in the business but they differ in their activity within the business.
- General partners are active in the business, doing the work of the company (being CPAs, for example) but also participating in management and decision-making.
- Limited partners are passive. They have invested in the business but they don't participate on a day-to-day basis in the running of the business.
There's actually a third kind of partner, the managing partner, a general partner who takes on added duties in the management of the partnership business affairs.
Considering Liability in Partnerships
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.
You may see that some business names have the word "limited" in them, like a limited partnership, limited liability partnership, or limited liability company (LLC). The use of this word means that some owners have limited liability personally against lawsuits and debts.
A partner who has limited liability is only liable for their investment in the partnership. For example, if a partnership declares bankruptcy, the limited partners must pay only the amount of their investment.
General partners are similar to sole proprietors in terms of liability. In both cases, the owners are not separate from the business in terms of liability for the debts of the business and for their actions. That is, they have full liability.
That's why new partnership types are often set up as limited partnerships of some type, or to form partnerships with limited partners, to limit the liability of one partner for the actions of other partners.
Limited liability companies (LLCs) with more than one member (owner) are taxed like partnerships and they operate in similar ways. The advantage of an LLC over a general partnership is in the limited liability of all owners.
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.
Advantage: Each partner can act independently, and each can invest in different types of capital. This partnership type also has low startup costs and few formalities.
Disadvantage: A general partnership operates as a sole proprietorship, with no separation between the partners and the business. Because general partners actively participate, their liability is not limited, as described above. If one partner is sued, all partners are held liable. A partner's personal assets may be taken by a court or creditor.
A limited partnership includes both general partners and at least one limited partner. 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 their liability is limited to their investment in the business.
Advantage: The limited partners are merely investors who don't want to participate in the partnership other than to provide capital and to receive a share of the profits. You may want to use the limited partnership option to form a partnership, for example, with relatives or friends who just want to invest.
Disadvantage: Because limited partners don't participate in management, they are considered passive investors. This means they can only take losses up to the amount of their income for the year.
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.
Advantage: Unlike the limited partnership, general partners in an LLP have limited liability.
Disadvantage: Because liability for all partners is limited, some businesses or individuals may be wary of doing business with the partnership.
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 (law, accounting, architecture, for example) 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.
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 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 (not a corporation) 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 their 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.
Partnerships and Tax Issues
As you are considering a partnership type, you should also consider how a partnership is taxed. The partnership, as a whole, files an information-only 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.
If you are interested in starting a partnership, this article takes you through the process step by step.