There are three primary forms of partnerships, each offering different structures of management, liability, and legal requirements:
1. General Partnership (GP)
A general partnership is created when two or more individuals agree to jointly run a business. No formal registration with the state is required. Instead, partners typically draft a partnership agreement outlining each person's roles, responsibilities, and profit-sharing terms.
- All partners co-manage the business.
- Each partner is personally liable for the debts and obligations of the partnership.
- Simple to form and operate without filing documents with the state.
2. Limited Partnership (LP)
In a limited partnership, the structure includes:
- At least one general partner who manages the business and assumes full liability.
- One or more limited partners who primarily invest in the business and whose liability is limited to their investment.
This type of partnership must be registered with the state. Limited partners generally do not participate in day-to-day management.
3. Limited Liability Partnership (LLP)
An LLP blends elements of general and limited partnerships. All partners can participate in managing the business, but each has limited liability, meaning they are not personally responsible for the actions or negligence of other partners.
- Popular among professionals such as lawyers, doctors, and accountants.
- Recognized in most states, though some restrict LLP formation to certain professions.
Should You Form a General Partnership?
Whether a general partnership is right for you depends on how involved you want to be in your business and whether you're comfortable sharing personal liability with others.
Advantages of a General Partnership
✅ Simple and Inexpensive to Form
- No need to file formation documents with the state.
- No annual reports or state fees required.
✅ Pass-Through Taxation
- The partnership does not pay income tax directly.
- Instead, profits and losses "pass through" to the individual partners, who report them on their personal tax returns.
- Partners may benefit from a 20% pass-through deduction under the Tax Cuts and Jobs Act, potentially lowering their taxable income.
✅ IRS Filing
- While not taxed, partnerships must file IRS Form 1065, which details each partner’s share of profits or losses.
Disadvantages of a General Partnership
❌ Unlimited Personal Liability
Each partner is personally liable for:
- Business debts
- Legal judgments
- Contractual obligations
For example, if the business owes rent or is sued, any partner’s personal assets (such as a home or car) can be used to satisfy the debt.
❌ Joint Liability
Any partner can be held responsible for the entirety of a business debt, regardless of who caused the issue.
Example:
If Partner A damages a client’s property, the client may sue Partner B for the full amount. Partner B can later pursue reimbursement from Partner A, depending on the terms of their agreement.
❌ Authority to Bind the Business
Each partner typically has the power to enter into contracts or financial commitments on behalf of the entire business. This means:
- One partner's actions may create obligations for all partners.
- Caution and mutual trust are essential.
Forming a Partnership: Key Steps
You don’t need to file with the state to form a general partnership. However, you'll likely need to:
- Register with your city or county tax authority
- Obtain an Employer Identification Number (EIN) from the IRS
- Apply for any necessary licenses or permits
- Comply with local zoning laws
- Register a fictitious business name (if operating under a different name)
📄 Draft a Partnership Agreement
Although not legally required, it's highly advisable to create a written agreement that defines:
- Ownership shares
- Profit and loss distribution
- Roles and responsibilities
- Decision-making processes
📄 Create a Buy-Sell Agreement
Also known as a buyout agreement, this outlines what happens if a partner:
- Retires
- Dies
- Becomes disabled
- Wants to exit the business
It ensures continuity or closure of the business in an orderly way.
Ending a Partnership
A partnership may be dissolved for several reasons, including:
- A partner decides to leave
- The partners mutually agree to close the business
- A partner dies or becomes incapacitated
- An event in the agreement triggers dissolution
- The business becomes insolvent
Final Steps Include:
- Settling outstanding debts
- Distributing remaining assets
- Officially notifying authorities and closing accounts