Partnership

Definition

The Uniform Partnership Act defines a partnership as “an association of two or more persons to carry on as co-owners of business for profit.” Oversimplifying, one might say that a partnership is a sole proprietorship that is owned by two or more people. However, the addition of the concept of multiple ownership greatly increases the legal complexity of the partnership form of business.

Legal and tax status

The partnership is generally not considered a legal entity in its own right. However, this general rule has been watered down and eroded in recent years. Partnerships are not suing and being sued in their own names. However, the legal importance of this is somewhat nebulous in that individual general partners will always be named along with the partnership in such legal actions.

A written partnership agreement is not legally necessary. However, a written partnership agreement is absolutely essential for a variety of business, legal and psychological reasons. All states have partnership statues and the analogy to probate statues is quite strong in the sense that if you do not write your own partnership agreement, the partnership statues effectively write one for you.

A well-prepared partnership agreement can require more legal skill than the formation of a corporation.

In the sole proprietorship, the sole proprietor is in total control and has total responsibility. In the partnership each individual general partner is not in total control but still is totally liable for the actions of the partnership, its employees and the other general partners. This adds a large degree of liability. Although you may control your employees, you may not be able to control the other general partners. Still, you are liable for their actions and commitments.

The death of a partner automatically dissolves the partnership and severely limits the rights of the survivors to continue acting on behalf of the partnership. However, a properly drawn partnership continuation agreement can give the business the benefits of a continuing existence.

State laws vary somewhat but generally a partner has a number of duties to the partnership. These may include the duties to:

• furnish full information;

• render service to partnership;

• not to profit secretly;

• not to compete with the partnership;

• demonstrate loyalty and good faith to partners and partnership.

A partnership is not a tax paying entity for purposes of the federal tax laws. However, a partnership is required to file a tax form, often called an information return. This form details partnership earnings, expenses and the distribution of the earnings to the partners. This information is then used by the partners to file their individual income tax returns. Thereafter, the partnership is similar to the sole proprietorship in that partnership income is added to any other income on the individual’s income tax return. Income and losses at the partnership level are allocated among the partners who account for these incomes and losses on their individual income tax returns.

A partnership must be registered with the state if it does business under an assumed or fictitious name.

Advantages

Flexible. The partnership is an extremely flexible form of business ownership. The range of arrangements and ownership mixes is virtually limitless. There is extremely broad latitude in the drafting of the partnership agreement itself.

Simple. At least on its surface, the partnership form is a simple method of business ownership. A written, formal partnership agreement is not required, although recommended, partners’ meetings are not required, and the structure of the partnership can be changed rapidly and relatively simply.

Taxation. Partnership taxation is basically individual income taxation. The greatest advantage to the partnership form of taxation is that losses at the partnership level will flow through to the individual partners and can be used to offset income on the individual return. Secondly, a partnership does not present the problem of double taxation since the partnership is not a tax paying entity. Simply stated, it is much easier to get money out of a partnership than out of a corporation. On the other hand, it is much easier to retain monies in a corporation than in a partnership.

Disadvantages

Liability. As mentioned earlier, although the individual general partner does not have complete control of the partnership, the general partner is completely liable for the actions of the other partners. This is in addition to normal business liability as with a sole proprietorship. It certainly means one is wise to choose his/her partners carefully, maintain open communications, purchase adequate liability insurance, and have a written partnership agreement.

As with the sole proprietorship, the general partner is liable for partnership liabilities to the complete extent of his or her personal assets. Furthermore, a new partner to an existing partnership may be liable for actions which occurred prior to his/her being a partner. In addition, after the partnership relation ceases a former partner may remain liable for actions that occurred while he/she was a partner.

This added layer of liability may be mitigated to some extent by a properly drawn partnership agreement. Of course, as stated earlier, adequate liability insurance is absolutely necessary.

Tax limitations. As noted, it is difficult to defer income through the partnership. Income flows through to the individual partners and is reportable by them on an annual basis.