What About Partnerships?
Partnerships can be complex to put it simply. They can be formed with an oral agreement, but a partnership agreement should be drafted and formed between the partners to ensure proper function of the partnership.
All or some partners must take full burden for any debts to the partnership as well.
There are two types of partnerships, general and limited, each of which are discussed below. Like all other business entities, partnerships are a creation of state law.
General partnerships, hereafter GP, consist of two or more partners, who engage in business together. As with S-Corporations, they pass-through entities and pass income/losses directly through to the partners. Each partner has complete and equal managerial control over partnership affairs unless there is a partnership agreement stating otherwise. Law governing general partnerships can be found in the Uniform Partnership Act (U.P.A.), which will essentially write your partnership agreement if you fail to write your own.
In a GP each partner has personal liability for all of the partnership debts. Under the Uniform Partnership act, general partners are jointly liable for partnership obligations. This means that each general partner must, in the event of the partnership being unable to pay its bills, pay the proportionate amount of the partnership debts equal to his ownership interest in the partnership.
Often the partner with the deeper pocket can even be liable for the full amount of the debt, with your only recourse of suing your partners for their share. Moreover, general partners are jointly and severally liable for the tortious acts of co-partners who are acting within the scope of the partnership business.
LP’s – Limited Partnerships
A special type of partnership is the limited partnership. To form a limited partnership, there are strict and inflexible statutory rules which must be followed, otherwise the attempt to form the limited partnership fails and a general partnership usually results instead. LP’s are formed by filing Articles of Organization or Certificate with the state. The filing certificate must contain whatever information is required by that state’s limited partnership act and signed by the partners.
Limited partnership agreements are typically more complex than general partnership agreements by the very fact that some partners are treated differently from others for certain purposes. Limited partnerships have one very large advantage over the general partnership: limited partners do not take on personal liability for the obligations of the partnerships, they are only liable to the extent of the money contributed to the partnership. Limited Partnerships must include at least one general partner in the limited partnership who retains all of the personal liability for partnership debts that one finds in the general partnership entity.
Although, the limited partnership must have at least one general partner who is personally liable for the debts of the partnership debt, this general partner does not have to be an individual. Since this general partner can be a corporation, this requirement does not mean that one of the members of the limited partnership needs to accept potentially ruinous liability.
It is important to know that the limited partner’s protection against personal liability can be lost in cases where a limited partner is found to participate in the control of the business beyond the limited role allowed to limited partners. What is the boundary of the limited role allowed to limited partners? How much participation is too much? Good question. This is an open question, so get help from your lawyer to help prevent the unintended loss of limited partnership status.
Tax Aspects of a Partnership
The good news is that partnerships are not subject to federal income tax on the income they earn. The bad news is that the partners are considered to have earned the income attributable to the partnership What happens is that at the end of the partnership’s tax year, the books for the year are closed out, and all money left over after bills, expenses, etc. are taken care of is (as far as the IRS is concerned) divided up among the partners according to their ownership percentages. And regardless of whether the money actually gets paid out in this, the IRS treats it as though all profits of the partnership have been distributed to the partners according to their ownership interests.
Although, partnerships are the most flexible of the entities in that they have a number of ways to allow you to allocate income, regardless of ownership percentage. Such as through guaranteed payments, payments that are guaranteed to be made to a partner irrespective of whether the partnership makes a profit or not. This can insure that a partner that contributes more assets or more time to the business are compensated for their contributions. Thus eliminating the risk of their making personal contributions of time or property for which they are never paid if the partnership is not successful.