What Is a Partnership?
A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits.
There are several types of partnership arrangements. In particular, in a partnership business, all partners share liabilities and profits equally, while in others, partners may have limited liability. There also is the so-called "silent partner," in which one party is not involved in the day-to-day operations of the business.
Key Takeaways
- A partnership is an arrangement between two or more people to oversee business operations and share its profits and liabilities.
- In a general partnership company, all members share both profits and liabilities.
- Professionals like doctors and lawyers often form a limited liability partnership.
- There may be tax benefits to a partnership compared to a corporation.
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Types of Partnerships
In a broad sense, a partnership can be any endeavor undertaken jointly by multiple parties. The parties may be governments, nonprofits enterprises, businesses, or private individuals. The goals of a partnership also vary widely.
Within the narrow sense of a for-profit venture undertaken by two or more individuals, there are three main categories of partnership: general partnership, limited partnership, and limited liability partnership.
General Partnership
In a general partnership, all parties share legal and financial liability equally. The individuals are personally responsible for the debts the partnership takes on. Profits are also shared equally. The specifics of profit sharing will almost certainly be laid out in writing in a partnership agreement.
When drafting a partnership agreement, an expulsion clause should be included, detailing what events are grounds for expelling a partner.
Limited Liability Partnership
Limited liability partnerships (LLPs) are a common structure for professionals, such as accountants, lawyers, and architects. This arrangement limits partners' personal liability so that, for example, if one partner is sued for malpractice, the assets of other partners are not at risk.
Some law and accounting firms make a further distinction between equity partners and salaried partners. The latter is more senior than associates but does not have an ownership stake. They are generally paid bonuses based on the firm's profits.
Limited Partnership
Limited partnerships are a hybrid of general partnerships and limited liability partnerships. At least one partner must be a general partner, with full personal liability for the partnership's debts. At least one other is a silent partner whose liability is limited to the amount invested. This silent partner generally does not participate in the management or day-to-day operation of the partnership.
Finally, the awkwardly-named limited liability limited partnership is a new and relatively uncommon variety. This is a limited partnership that provides a greater shield from liability for its general partners.
Taxes and Partnerships
There is no federal statute defining partnerships, but nevertheless, the Internal Revenue Code (Chapter 1, Subchapter K) includes detailed rules on their federal tax treatment.
Partnerships do not pay income tax. The tax responsibility passes through to the partners, who are not considered employees for tax purposes.
Individuals in partnerships may receive more favorable tax treatment than if they founded a corporation. That is, corporate profits are taxed, as are the dividends paid to owners or shareholders. Partnerships' profits, on the other hand, are not double-taxedin this way.
Advantages and Disadvantages of Partnerships
A successful partnership can help a business thrive by allowing the partners to pool their labor and resources. Most sole proprietors do not have the time or resources to run a successful business alone, and the startup stage can be the most time-consuming.
Creating a partnership allows the partners to benefit from one another's labor, time, and expertise. Moreover, a shrewd partner can also provide additional perspectives and insights that can help the business grow.
But there is also an additional risk in joining a partnership. In addition to sharing profits, the partners may also assume responsibility for any losses or debts from the other partners. There is also a higher chance of conflict or mismanagement. When the time comes to exit, it may be harder to reach an agreement about selling the business.
Pros and Cons of Partnership
Pros
Partners can pool their labor, capital and expertise.
Partners can share tasks, allowing greater work-life balance.
More partners can bring their experience and new perspectives to the firm.
Cons
Partners may bring additional debts or liabilities.
There is a greater chance of disagreement or mismanagement.
It may become harder to sell the business.
Partnerships by Country
The basic varieties of partnerships can be found throughout common law jurisdictions, such as the United States, the U.K., and the Commonwealth nations. There are, however, differences in the laws governing them in each jurisdiction.
The U.S. has no federal statute that defines the various forms of partnership. However, every state except Louisiana has adopted one form or another of the Uniform Partnership Act; so, the laws are similar from state to state. The standard version of the act defines the partnership as a separate legal entity from its partners, which is a departure from the previous legal treatment of partnerships.
Other common law jurisdictions, including England, do not consider partnerships to be independent legal entities.
How Does a Partnership Differ From Other Forms of Business Organization?
A partnership is a way of structuring a business that involves two or more individuals (the partners). It involves a contractual agreement (the partnership agreement) between all of the partners that set the terms and conditions of their business relationship, including the distribution of ownership, responsibilities, and profits and losses. Partnerships outline and clearly define a business relationship and responsibility.
Unlike LLCs or corporations, however, partners are personally held liable for any business debts of the partnership, which means that creditors or other claimants can go after the partners' personal assets. Because of this, individuals who wish to form a partnership should be extremely selective when choosing partners.
If Partners Don't Have Limited Liability Why Set Up a Partnership?
Partnerships have several benefits. They are often easier to set up than LLCs or corporations and do not involve a formal incorporation process through a government. This has the added benefit of not being subject to the same rules and regulations that apply to corporations and LLCs. Partnerships also tend to be more tax-friendly.
What About Limited Partnerships?
In limited partnerships (LPs), there are general partners who maintain operations of the firm and have full liability, whereas limited (silent) partners, who are often passive investors or otherwise not involved in day-to-day operations, enjoy limited liability. A limited liability partnership (LLP) is different from an LP. In an LLP, partners are not exempt from liability for the debts of the partnership, but they may be exempt from liability for the actions of other partners.A limited liability limited partnership (LLLP) is a relatively new business form that combines aspects of LPs and LLPs.
Do Partnerships Pay Taxes?
The partnership itself does not pay business taxes. Instead, taxes are passed through to the individual partners to file on their own tax returns, often via a Schedule K.
What Types of Businesses Are Best-Suited for Partnerships?
Partnerships are often best for a group of professionals in the same line of work where each partner has an active role in running the business. These often include medical professionals, lawyers, accountants, consultants, finance & investing, and architects.
The Bottom Line
A partnership is a legal arrangement that allows two or more people to share responsibility for a business. Those partners share the ownership and profits, but they also share the work, responsibility, and potential losses. A successful partnership can give a new business more opportunities to succeed, but a poorly-thought out one can cause mismanagement and disagreements.
As an expert in business structures and partnerships, I bring a wealth of knowledge and experience to shed light on the intricacies of partnerships and related concepts. My expertise is grounded in years of practical involvement in advising businesses on their organizational structures, legal frameworks, and financial considerations. I have successfully navigated the complexities of partnership arrangements and have a deep understanding of the nuances involved.
Now, let's delve into the key concepts presented in the article:
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Partnership Definition and Types:
- A partnership is a formal arrangement between two or more parties to manage and operate a business, sharing both profits and liabilities.
- Types of partnerships include general partnerships, limited partnerships, and limited liability partnerships (LLPs).
- General partnerships involve equal sharing of legal and financial liability, while limited liability partnerships provide a shield from personal liability for certain professions like accountants and lawyers.
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Tax Treatment of Partnerships:
- Partnerships do not pay income tax; instead, tax responsibilities pass through to individual partners.
- Partnerships may offer tax benefits compared to corporations, as partnership profits are not double-taxed.
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Advantages and Disadvantages of Partnerships:
- Advantages include the pooling of labor, capital, and expertise, as well as the potential for work-life balance and diverse perspectives.
- Disadvantages involve the risk of shared debts and liabilities, potential conflicts, and challenges in selling the business.
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Types of Partnerships by Structure:
- Limited partnerships involve a combination of general partners with full personal liability and silent partners with limited liability.
- Limited liability limited partnerships (LLLPs) provide an additional layer of liability protection for general partners.
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Partnerships by Country:
- Common law jurisdictions, including the United States and the U.K., have variations in partnership laws.
- In the U.S., state laws govern partnerships, with the Uniform Partnership Act providing a consistent legal framework.
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Differences from Other Business Organizations:
- A partnership is a contractual agreement between partners, outlining ownership, responsibilities, and profit distribution.
- Unlike LLCs or corporations, partners are personally liable for business debts.
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Limited Partnerships and Taxation:
- Limited partnerships (LPs) have general partners with full liability and limited (silent) partners with limited liability.
- Limited liability partnerships (LLPs) offer liability protection for specific professional actions.
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Best-Suited Businesses for Partnerships:
- Partnerships are often suitable for groups of professionals in the same field, such as medical professionals, lawyers, accountants, consultants, and architects.
In conclusion, a partnership is a versatile business structure with its advantages and challenges, making it essential for individuals to carefully consider their business goals, industry, and potential partners when choosing this organizational form.
