Partnerships, explained

Every company founder is faced with the question of which legal form is the right one for their company. In principle, the first choice is between a corporation and a partnership. As in the case of corporations, there are also different legal forms for partnerships. Here, you can find out what a partnership is and what distinguishes it from a corporation. We also explain the advantages and disadvantages of the different types of partnerships.

What is a partnership?

A partnership is the merger of several “legal entities” that pursue a common goal. Depending on their legal form, these legal entities can be natural persons, legal bodies (usually corporations), or other partnerships. A characteristic feature of this kind of company is the close relationship between the company and the shareholders. This is mainly due to the fact that these partners are usually personally liable without limitation, and this clearly distinguishes a partnership from a corporation.

The partnership has legal capacity, i.e. it can acquire property and also appear in court. Unlike a corporation, however, it is not a legal entity. This means that it does not legally exist independently of its shareholders. As the name suggests, the focus is on people involved, and the shareholders and company are never completely separated from each other.

Another difference between a partnership and corporation is the generally simpler legal framework for the formation and operation of a partnership. This makes it an attractive choice for start-up teams and project groups in particular.

Definition

A partnership is an association of at least two legal entities for the pursuit of a common business goal. The basis of this merger is a partnership agreement. In this kind of company, partners are personally liable without limitation (with certain exceptions).

Minimum deposits and liability

In contrast to a corporation, the legal obligation of partners for the liabilities of a partnership is not limited to their respective capital participation. Rather, as a rule, they are personally liable, without limits. On the other hand, a partnership does not require a minimum contribution from the shareholders when it is formed.

If you make the decision to choose a partnership structure for your business, you may be saving money on registration and setup costs, but you will be taking a greater financial risk than with a corporation. In a limited partnership, some partners are liable as limited partners only up to their capital contribution. However, there also must be one or more general partners, who, if necessary, are fully liable for the company’s liabilities.

Management

In a partnership, the partners manage the business themselves (though this role is usually assigned to just one or two of them). In contrast, this is not necessarily the case with limited companies: outsiders can also take over the management of the company (as a so-called foreign entity). In partnerships, this is not only possible in the form of representation.

A range of legal forms

There are a number of different types of partnership your business can take within the US. These different types have their own characteristics, relating to membership and liability. The following list will cover all you need to know about the different kinds of partnership options out there. Here is a list of partnership examples:

Sole proprietorship

Although this business legal structure is not a partnership, it is worth noting that being a sole proprietor does not always mean what the name implies: a sole proprietor means there is just one owner of a business, who is entitled to any and all profits and liable for any and all losses. However, there is one caveat to this: if you are married, you and your marital partner may jointly own a business as a single legal entity. This legal structure is the easiest to start up and run, and has fewer legal and tax obligations. However, it is not classified as a partnership and is only suited to a married couple looking to go into business.

General partnership

General partnerships are the simplest, most common partnership structure. A general partnership consists of two or more general partners who are responsible for providing capital and equipment to start the business, and also share management of the business. They are all involved in all aspects of the business and are all liable for any debts incurred. The degree to which each person is involved and liable is usually set out in a partnership agreement before the business is formed. General partnerships also have important tax structures. In a general partnership, the individual partners are taxed separately, rather than the business itself.

Once you and your partners have decided to form a general partnership, you will need to choose a name for your business and check your chosen name’s availability with the local county registrar and the Secretary of State’s office. It is also worth considering whether you want to register your company’s name with the US Patent and Trademark Office to guarantee its protection.

There are a few bureaucratic steps to take before you can open for business. You will need to register your business with the Secretary of State office to ensure that you have given public notice of your company’s general information. Your next step is to register with the Internal Revenue Service (IRS) to get your federal tax identification number (EIN). You will need this to open a business bank account for your company. Contact your bank ahead of time to find out if there are additional documents you require to open an account. Some banks ask for a fictitious name certificate (if the business’s name is not the name of the partners) or a copy of the partnership agreement.

In terms of taxation, general partnerships have two obligations: state and federal taxes. You will need to register your business for sales tax with your local authorities. If your business intends to operate in more than one state, you will have to register with each state. You will also be required to register for federal taxes through the Electronic Federal Tax Payment System. This is necessary for filing employment and payroll taxes if you have employees.

Your final step is to ensure that you have obtained any and all relevant required local and state licenses to operate your business. These vary depending on the type of business you have and which states you operate in, so be sure to consult with your local Secretary of State office to ensure that you have the right licenses.

As always, if you are unsure or have any questions about setting up your general partnership, consulting with a legal tax professional is the best course of action. This will guarantee that you have all your permits in order and are legally watertight in terms of business operations and taxation.

Limited partnership

A limited partnership is defined as a partnership in which not all shareholders are personally liable for the company’s liabilities. What makes them different is that they are made up of general partners and limited partners. Their rights in terms of the company are limited, and they are usually not allowed to participate in management. They are simply there as silent investors, and are only liable up to the amount of their investment (capital contribution). There is no minimum amount for a capital contribution, unless otherwise stated in the partnership agreement.

Like general partners, limited partners are legal entities, which may consist of persons, corporations, or other partnerships. Since limited partners are only liable for the sum of their investment, this makes the limited partnership an easy business structure to raise capital with.

The procedure for setting up a limited partnership is similar to a general partnership, except that all limited partnerships are required to register with the Secretary of State (in some states, general partnerships are not required to register before becoming legal businesses). Limited partnerships are also required to have a registered agent (legal representative for limited partnership) and provide their name and address publicly so that you have a verifiable point of contact. Different states have different information requirements, so contact your Secretary of State office to find out if any additional information about your registered agent is necessary.

In nearly all states, you are required to file a certificate of limited partnership, signed by all partners. This certificate normally includes the limited partnership’s name, office address, registered agent information, purpose of the limited partnership, value of al partners’ capital contribution, and the names and addresses of all partners.

Limited liability partnership (LLP)

A relatively new form of partnership is the limited liability partnership (LLP). This is a partnership where all the partners have limited liability, i.e. there are no true general partners. In this regard, although an LLP has a partnership structure, it incorporates aspects of a corporation (particularly limited liability corporations).

LLPs appeared in the US in the 1990s. Due to the collapse of many banks and saving institutions in the 1980s, attempts were made to hold lawyers and accountants who had advised these institutions financially liable. As a result, LLPs were introduced that would protect partners who were not involved from the liabilities of others in their company.

However, there are sometimes restrictions on what professional uses an LLP may be used for. They are particularly popular for lawyers, accountants, and architects – businesses where individual reputation is paramount. In some states, LLPs may only be formed for these professions. The amount of liability each partner in an LLP is responsible for also depends on the state. Federal legislation regulating the formation and running of LLPs was passed in 1994 in the Revised Uniform Partnership Act.

If you are interested in forming an LLP, the procedure is similar to a general or limited partnership, again with a few changes. First off the bat, you will need to ensure that your business qualifies to be an LLP. Some states (New York, Oregon, California) place restrictions on what professions may form an LLP.

You may need to file a certificate of limited liability partnership – and each state allows LLPs to establish their own requirements for filing a certificate of limited liability partnership. This is a more general version of your limited liability partnership agreement. Filing fees range between $50 and $500, depending on the state. Some states also require that LLPs acquire certain kinds of insurance for the business, such as worker’s compensation insurance or malpractice liability insurance. Some states require you to announce your LLPs formation publicly. Consult with your Secretary of State office or Department of Industrial Relations to confirm whether both of these steps are necessary in your state.

How are partnerships taxed?

One of the reasons that partnerships are such a popular business form is because of their taxation structure. Partnerships are classified as “flow through” entities for taxation purposes. This means that rather than having the business taxed itself, any income “flows through” to the partners and they are taxed on it as part of their individual tax returns. This means that the business is not liable for corporation tax.

Partners in a business partnership are required to file their profits as part of their individual tax return using form 1065, Return of Partnership Income. While the business is not required to pay tax on profits itself, it may be liable for employment taxes if you have any employees. If so, you will need to file form 941, Employer’s Quarterly Federal Tax Return. Depending on the kind of business the partnership is, it may also be liable for excise tax for goods purchased.

Overview of the various forms of partnership

Company founders can choose from a range of legal forms, depending on the preconditions and preferences of their partnerships. Here is an overview of the relevant ones:

Legal form Acronym Characteristics Typical application examples
General partnership GP (rarely used) Merger of at least two legal entities for the purpose of a joint commercial activity, partners fully liable for company debts, partners can act individually in managing the business registration with the Secretary of State Small businesses, manufacturers, trade and craft enterprises
Limited partnership LP (rarely used) Merger of at least two legal entities for the exercise of a joint commercial activity, general partners are personally liable without limitation, limited partners are only liable up to the amount of their equity contribution, limited partners do not participate in the business other than capital contributions Companies in which not all shareholders are equally liable, e.g. capital providersParticularly suitable for family-owned businesses where responsibility is not to be shared equally in the event of inheritance
Limited liability partnership LLP Merger of at least two legal entities for the exercise of a joint commercial activity pertaining to their specific professions, must file a certificate of limited liability with their local authorityThe partners are only liable for unlimited and joint liabilities; each partner is individually liable for professional mistakes. Freelancers, e.g. journalists, doctors, architects, lawyers, engineers, tax consultants, business consultants

Advantages and disadvantages of different partnerships

If you have decided to form a partnership when setting up your company, further criteria come into play when choosing the right legal form. These include the type of activity, the size of the planned company, the partner’s personal preferences, the participation of other companies, and more. Here, you will find an overview of the typical advantages and disadvantages of the various legal forms, which can help you in your choice of partnership.

Legal form Advantages Disadvantages
General partnership All shareholders have an equal stake and say in business activities and profits, flow through taxation All partners are fully personally liable for company debts
Limited partnership Limited partners are only liable up to the amount of their capital contribution, easy and relatively secure way to invest in a company, fewer partners involved in management, flow through taxation Limited partners may have high influence without the liability, general partners personally liable for company debts
Limited liability partnership No shared liability for professional mistakes by other partners, low running costs, flow through taxation Often limited to individuals within a certain profession, may be required to take out additional insurances or file additional paperwork

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