When two or more people come together and agree to pool their resources and skills into a business as co-owners this is known as a partnership. A partnership agreement indicates how the partners agree to operate the business. The Uniform Partnership Act defines a partnership and shows that a partnership agreement can be written, oral, or implied among the partners. Most partnership agreements include important information such as the names of the partners, the name of the partnership, the business being operated, the property of the business, the contribution of each partner, provisions for settling differences, and provisions for dissolution of the partnership.
As co-owners of the business, the partners share equal claims to the assets of the partnership, but only for the purposes of the partnership. Generally, there are two kinds of partnerships that businesses can form, the general partnership and the limited partnership.
The general partnership is a partnership, which allows each partner to be completely active in the firms operation and management. Each partner is a representative of the business and the other partner(s) with the authority to act within the scope of the business’s activities. Every partner in the general partnership is able to share in all the profits of the business, and remains entirely responsible for the debts of the business.
The limited partnership has at least one general partner and at least one limited partner. The limited partner remains not legally liable for the debts of the business. The limited partner usually places an investment into the business and their liability ends with that investment. This partner does not participate in management of the business nor are they involved in running the daily activities of the business.
Profit Share– The partners are able to retain all of the profits the business makes. There are no stockholders to claim the earnings of the business. The profits are split between the partners how it is spelled out in the partnership agreement.
Resource Pooling– As a change from sole proprietorships, partnerships allow a pooling of resources, capital, risk and talent. Partners are able to divide up tasks to fit each partner’s ability.
Federal Taxes– The partnership is free from accumulated earnings tax as well as the federal income tax. The profit and loss of the partnership pass directly through to the partners as personal income for federal income taxes. Any losses incurred by the partnership can be used by the partners to offset income made from other sources. This can reduce the federal income tax bill paid by the partners. The partnership is required to file Form 1065 to report gross partnership income, taxable income, and business deductions.
Authority– For general partnerships, each partner has equal authority with the other partners. Unless specifically restricted, each partner is able to transact business and sign contracts on the businesses behalf. The limited partner is not this involved in the business in this manner.
Unlimited Liability– General partners are subject to unlimited liability. Business debts can consume the business’s assets as well as the personal assets of each partner. However, limited partners are not bound by the financial obligations of the firm that exceed the limited partner’s investment.
Share– When compared to a sole proprietorship sharing profits is a disadvantage of the partnership. Instead of being able to control or walk away with every dime earned by the business, the profits are split between the partners.
Partner Death– The partnership can automatically terminate when one of the partners die. This can lead to consequences for all interested parties. This can be circumvented with an ownership transfer plan.
Lawsuits– A lawsuit may be brought against the individual members of a partnership. Some states consider a partnership a separate entity and allow the partnership to sue and be sued.
A few noteworthy items to mention about partnerships:
- Limited partners cannot be active in the firm’s management as they are essentially investors.
- Other kinds of partnerships exist such as Family Limited Partnership (FLP), Professional Partnerships, and Commercial Partnerships.
- Family limited partnerships are sometimes used for estate planning. This allows family members to transfer property to the partnership and receive partnership units.
- Professional partnerships have partners that are qualified members of a given profession like a medical, accounting, or engineering partnership.
- Commercial partnerships are typically companies that manufacture or sell products, but are formed as a partnership.
The next business form that will be explained is the C Corporation.
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