Partnerships share a lot of similarities with sole proprietorships—the key difference is that the business
has two or more owners. There are two kinds of partnerships: general partnerships (GPs) and limited
partnerships (LPs). In a general partnership, all partners actively manage the business and share in the
profits and losses.
Partnerships are businesses operated by two or more owners. Most partnerships are known as general
partnerships, but there can also be limited partnerships or limited liability partnerships. Business
owners who are a part of the partnership must pay income taxes,
self-employment taxes
, and quarterly
estimated taxes.
If you operate a partnership, the business has to file a Form 1065,
which is an annual information return that shows the income, deductions, gains, and losses from the
business’s operations—but the business itself doesn’t pay any income tax. Partnerships enjoy what’s
called “pass-through taxation,” meaning the income is taxed on the owners of the business instead of being
subject to corporate tax rates
To file taxes, owners who are included in the partnership have to file their respective share of the
business’s income and losses on their personal tax returns. Each partner’s share of the business’s income
and losses is shown on a Schedule K-1.
General Partnership
General Partnership Definition
A general partnership is an unincorporated business with two or more owners who share business
responsibilities. Each general partner has unlimited personal liability for the debts and obligations of
the business. Each partner reports their share of business profits and losses on their personal tax
return.
There are several types of business partnerships, but the most common is a general partnership. When two or
more people agree to run a business together, without registering or incorporating the business, it is a
general partnership. General partnerships are quite common among the different types of business entities
because they are simple, both in terms of getting started and filing taxes.
If you’re going into business with partners, it’s important to understand how a general partnership
compares to other types of partnerships and to other business structures. We’ll cover how a general
partnership works, the pros and cons, and whether it’s a good fit for your company.
How a General Partnership Works
A general partnership is an unincorporated business, which means that you don’t need to register your
business with the state in order to legally operate. In fact, when two or more people go into business
together with the goal of earning a profit, a general partnership exists by default.
More specifically, in order to have a general partnership, there are two conditions that must be true:
- The company must have two or more owners.
- All partners must agree to have unlimited personal responsibility for any debt or legal liability that
the partnership might incur.
In a general partnership, every partner has the authority to enter into contracts or business deals that
are binding on every other partner. While this can be convenient, it also means that you should really trust
the person or persons with whom you launch your company. It might be fun to start a business with a friend
or family member, but they might not necessarily make the best fit as a business partner. Your partner’s
actions or mistakes can impact you legally and financially, which we’ll explain more about in the next
section.
To prevent and resolve disagreements, owners in most general partnerships create a founders’ agreement or
partnership agreement. The agreement outlines the governing structure of the business and each owner’s
rights and responsibilities. Provisions for partner voting rights and the division of profits are also
typically written into the agreement.
In the absence of a partnership agreement, general partnerships dissolve when one of the partners passes
away, becomes disabled, or leaves the partnership. An agreement can specify what should happen in these
circumstances. For example, if one partner dies, the surviving partner or partners might get the first
opportunity to buy out that individual’s share.
Compensation in a General Partnership
General partners are entitled to receive compensation for their participation in the partnership. Partners
aren’t considered employees, so the compensation isn’t in the form of a salary. Instead, partners receive
distributions from the partnership’s profits, in line with their share of profits as outlined in the
partnership agreement (profits are equally distributed if there’s no agreement).
Distributions are considered self-employment income and are subject to
self-employment taxes
for social
security and Medicare. Any money that’s not distributed can be retained by the partnership for reinvestment
in the company, but partners still have to pay taxes on retained earnings.
Taxes in a General Partnership
General partnerships don’t pay business income taxes because they are pass-through entities. This means
that the income and losses of the partnership are reflected on the personal tax return of each owner. Each
owner pays their personal income tax rate on their share of the business profits. Pass hru entities have a
partners' respective share of his/her income "pass thru" to their own personal return (1040) and tax is
cxomputed there.
Even though partnerships aren’t taxed, the partnership must complete and give a Schedule K-1 to each owner
no later than March 15. Schedule K-1 summarizes each owner’s share of business income, losses, credits, and
deductions. Each partner uses the information in the Schedule K-1 to complete their personal 1040 tax
return. Income for general partners is usually treated as self-employment income, so the partner should
attach Schedule SE to their 1040. In addition, the partnership must file Form 1065 as an informational
return with the IRS no later than April 15.
Like a
sole proprietorship
a general partnership is the default mode of ownership
for multiple-owner businesses—there’s no need to register a general partnership with the state.
Fiduciary Duties in a General
Partnership
You might be surprised that partners can be held liable for acts they didn’t commit, but fiduciary duties
can help protect owners in a general partnership. There are four types of fiduciary duties among general
partners:
- Duty of Good Faith and Fairness: Partners must act honestly and fairly in all
activities that impact the business.
- Duty of Loyalty: Partners should place the best interest of the partnership above their
own interests, and avoid any conflicts of interest that could hurt the partnership.
- Duty of Disclosure: Partners should disclose the potential benefits and risks known to
them of a prospective business decision, so that the partners can make an informed choice about whether to
pursue it. Partners might have to disclose information about business activities, finances, contracts,
etc.
- Duty of Care: Partners must use reasonable care when managing the partnership. For
example, partners should document important business matters in writing and maintain books for financial
transactions.
These fiduciary duties arise from the very moment that the partnership starts and continue until the
partnership is dissolved. State law might specify additional fiduciary duties, but business owners can add
to or modify certain fiduciary duties with a partnership agreement. If a partner breaches a fiduciary duty,
the other partners can sue.
Management and Control in a
General Partnership
Partners have flexibility in deciding how to manage and run the business on a day to day basis. A
partnership agreement can specify different areas of responsibility and different privileges for each owner.
You can distribute voting rights and profit share however you see fit. Some partnerships specify a few
managing partners to take the lead on business matters.
One of the few things you can’t change with a partnership agreement is your state’s rules on joint
liability or joint and several liability. Partners can split ownership interests and profit
any way they like, but all general partners are equally liable for debts.
In the absence of a partnership agreement, the majority of states follow the Revised Uniform Partnership
Act (RUPA or UPA). This is a model statute that provides standard rules about how a partnership should be
governed and the rights and duties of each partner. Under RUPA, all partners have equal voting rights and
profit shares, even if one partner contributes more resources or money to the company.
Pros of General Partnership
- Easy to start up (no need to register your business with the state).
- No corporate formalities or paperwork requirements, such as meeting minutes, bylaws, etc.
-
You don’t need to absorb all the business losses on your own because the partners divide the profits and
losses.
- Owners can deduct most business losses on their personal tax returns.
Cons of General Partnership
- Each owner is personally liable for the business’s debts and other liabilities.
-
In some states, each partner may be personally liable for another partner’s negligent actions or
behavior (this is called joint and several liability).
-
Disputes among partners can unravel the business (though drafting a solid partnership agreement can help
you avoid this).
-
It’s more difficult to get a business loan, land a big client, and build business credit without a
registered business entity.
Most people form partnerships to lower the risk of starting a business. Instead of going all in on your
own, having multiple people sharing the struggles and successes can be very helpful, especially in the early
years.
That being said, if you do go this route, it’s very important to choose the right partner or partners.
Disputes can seriously limit a business’s growth, and many state laws hold each partner fully responsible
for the actions of the others. For example, if one partner enters into a contract and then violates one of
the terms, the party on the other side can personally sue any or all of the partners.
Limited Partnership
Limited Partnership Definition
A limited partnership is a partnership in which there are two types of partners—general and limited
partners. General partners manage the business and are jointly liable for the debts and obligations of the
business. Limited partners have limited liability for business debts and obligations but don’t actively
manage the business.
When starting a small business, your choice of business entity is one of the most important decisions to
make. The decision can be especially complicated if you go into business with multiple partners or plan on
acquiring investors. The limited partnership, recognized in all 50 states, is a variation of a regular
partnership.
After the advent of the limited liability company (LLC) in the 1970s and 1980s, limited partnerships have
declined in popularity. However, certain types of businesses, such as real estate companies and family-owned
businesses, can still benefit from a limited partnership structure. Learn more about how limited
partnerships work, how they compare to other types of partnerships, and how to form a limited partnership in
your state. We’ll also help you evaluate the pros and cons of limited partnerships.
How Limited Partnerships Work
A partnership is a business that is owned by two or more individuals, who each contribute something of
value to the company, such as money, property, skills, or labor. Partners share in the profits and losses of
the company. All of this remains true in a limited partnership, but a limited partnership has two different
types of partners—general and limited partners.
General partners participate in the day-to-day management of the business. Each general partner faces full
personal liability for the debts, obligations, and activities of the partnership. This means if someone has
a legal claim against the partnership, they can sue any or all general partners. They can even lay claim to
the general partners’ personal assets if the business assets of the partnership aren’t sufficient.
As their name suggests, limited partners play a much more limited role in the business. Limited partners
are often called “passive investors” or “silent partners.” They typically contribute money to the business,
and share in the income stream of the business. However, they don’t participate in the day to day management
of the company. And like shareholders in a corporation, limited partners are only liable for business debts
and obligations up to the extent of their investment in the company. In other words, if a limited partner
invests $1 million in the business, that’s the maximum they can be personally accountable for in a lawsuit
against the company.
When are Limited Partnerships Useful?
Limited partnerships are not as popular among small business owners as some other business entity types,
especially LLCs and
S-corporations
. However, there are special instances in which they are common.
- Family businesses: Many family-owned businesses designate one or two members of the
family as general partners with management responsibility. The other family members are limited partners,
sharing only in the income of the business. Eventually, management responsibility passes on to younger
family members who inherit the business. This is sometimes called a family limited partnership.
- Commercial real estate projects: A limited partner often fronts money for large
commercial real estate projects, such as shopping malls and apartment complexes. The limited partner
receives financial benefit from the income generated by the project, but they designate a general partner
to oversee completion of the project itself.
- Professional businesses: In professional industries, such as doctor’s offices and law
firms, older, retiring members might wish to stay involved as limited partners. They’ll cede management
control of the company to general partners.
- Estate planning: A limited partnership can be used as an estate planning tool, where the
general partner holds real estate on behalf of the heir. The asset produces an income stream for the heir,
who will eventually hold the real estate in their own right.
In the examples mentioned above, the ability to pool the resources of general and limited partners can be
critical to getting the business off the ground. General partners bring skills and labor to the table, while
limited partners bring financial resources.
Even Warren Buffet started out with a limited partnership called Buffet Associates Ltd. The company
included seven of his family members and friends. Buffet was the general partner, and put in just $100 of
his own money. His family and friends were limited partners and contributed a sizable initial investment.
With his investing prowess, Buffet grew the group’s initial investment of $105,000 to $105 million in assets
within 13 years!
Limited Partnership Taxes
Limited partnerships are pretty similar to general partnerships when it comes to taxes. A limited
partnership is a pass-through entity, which means the partnership itself doesn’t pay taxes in the way a
corporation would. The partnership fills out Form 1065 as an informational return and provides a Schedule
K-1 to each partner with details the partner’s share of the company’s income and losses. Using the Schedule
K-1, each partner then reports their share of the business income and losses on their personal tax return.
The income is taxed at the owner’s personal income tax rate.
If business losses are greater than profits, partners in a limited partnership can deduct losses up to
their investment in the businesses. If their losses are greater than their investments, they can carry the
losses to other years to offset the profitability of those years. But since limited partners don’t
participate in the management of the business, their income is called passive income or loss. Passive income
or losses can only offset other passive income.
One tax advantage of limited partnerships is that only general partners have to pay
self-employment taxes
on their earnings from the company.
Self-employment taxes
cover social security and Medicare taxes. Limited partners don’t have to pay
self-employment taxes
(except on guaranteed payments received for services provided to the partnership) because they don’t
participate in the day-to-day management of the business.
Limited Partnership Compliance
One tax advantage of limited partnerships is that only general partners have to pay
self-employment taxes
on their earnings from the company.
Self-employment taxes
cover social security and Medicare taxes. Limited partners don’t have to pay
self-employment taxes
(except on guaranteed payments received for services provided to the partnership) because they don’t
participate in the day-to-day management of the business.
The best rule of thumb is to understand your state’s laws and requirements as well as possible. Every
state, except Louisiana, has enacted some version of the Uniform Limited Partnership Act.
Limited Partnerships vs.
Other Types of Partnerships
There are several different kinds of partnerships. The main thing partnerships have in common is that
multiple people own the business, and they all share in the profits and losses of the business. However,
each type of partnership is very different in terms of management structure and the division of resources
and liability. Limited partnerships have two kinds of partners—general and limited partners. General
partners are exposed to personal liability, but manage the business on a daily basis. Limited partners
invest money in the business and are shielded from personal liability beyond the amount of their
investments. However, limited partners don’t participate in daily management of the company.
General Partnership
As mentioned above in brief summary on a general partnership:
-
A general partnership is one of the simplest types of business entities to start. In fact, if you start
a business with multiple owners and don’t register your company with the state, your business is a general
partnership by default.
-
In a general partnership, all the owners share in the management responsibilities, profits, and losses.
Each owner is also fully personally liable for the debts and obligations of the business. Each partner
owes fiduciary duties of loyalty, care, and good faith to the partnership and other partners.
Joint Venture
A joint venture is a temporary general partnership that two or more people or companies start for a
particular purpose. Usually, a joint venture expires when the project is completed or on a specific date, so
it is more limited in scope than a general partnership.
Similar to a general partnership, the parties to a joint venture are personally liable for the debts and
obligations of the business and owe a fiduciary duty to one another. A joint venture might also be launched
as a separate LLC or corporate entity, in which case partnership rules wouldn’t apply.
Limited Liability Partnership
A limited liability partnership (LLP) has no general partners. In this type of business, all partners have
limited personal liability for the debts and obligations of the business. LLPs are popular among
professionals, like doctors and architects. In fact, in some states, the LLP structure is only available to
professionals. Professionals like to form LLPS so that they can actively participate in the business but
aren’t personally liable for malpractice claims filed against their colleagues.
Limited Liability Limited Partnership
There is yet another type of partnership called limited liability limited partnership (LLLP) that’s only
recognized in some states. An LLLP is similar to a limited partnership because it has general and limited
partners. However, the big difference is that the general partners have limited personal liability for the
partnership’s debts and obligations. That means if the partnership is sued, all partners are responsible
only up to the amount of their investment. LLLPs are popular among groups of real estate developers, who
seek to limit their exposure to what they’ve invested in a project.
Limited Partnership (LP) Pros and Cons
Unlike a general partnership, a limited partnership is a registered business entity.
To form an LP, you must file paperwork with the state. In an LP, there are two kinds of partners: those who
own, operate, and assume liability for the business (general partners), and those who act only as investors
(limited partners, sometimes called “silent partners”).
Limited partners don’t have control over business operations and have fewer liabilities. They typically act
as investors in the business and also pay fewer taxes because they have a more tangential role in the
company.
Pros of Limited Partnership
-
An LP is a good option for raising money because investors can serve as limited partners without
personal liability.
-
General partners get the money they need to operate but maintain authority over business operations.
- Limited partners can leave anytime without dissolving the business partnership.
Cons of Limited Partnership
- General partners are personally responsible for the business’s debts and liabilities.
- More expensive to create than a general partnership and requires a state filing.
-
A limited partner may also face personal liability if they inadvertently take too active a role in the
business.
Multi-owner businesses that want to raise money from investors often do well as LPs because investors can
avoid liability.
You might come across yet another business entity structure called a limitedliability partnership (LLP).
In an LLP, none of the partners have personal liability for the business,
but most states only allow law firms, accounting firms, doctor’s offices, and other professional service
firms to organize as LLPs. These types of businesses can organize as an LLP to avoid each partner from
having liability for the other’s actions. For example, if one doctor in a medical practice commits
malpractice, having an LLP lets the other doctors avoid liability.
