What Is a Business Partnership?
A business partnership can provide new or existing companies with the access to skills, capital and support necessary for success — but there are risks. A general partnership, for instance, is easy to set up, but can leave members liable for the debts of the business and their partners. Limited partnerships offer greater protections, but may come with state-by-state limitations.
Before deciding on a business entity, be sure to consider partnership business advantages and drawbacks versus other available business structures.
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Business partnership definition
A business partnership is a way of structuring a company owned by two or more individuals. Common examples of partnerships include law firms, physician and accounting groups, as well as real estate firms.
Not all partnerships are the same, however. The type of business partnership that’s right for you depends on the level of liability you and your partner(s) want to accept for the business’s debts and any lawsuits that may be filed against it. Laws in the state where you’re doing business may also restrict the type of partnership you can consider.
The types of partnerships
There are three primary types:
1. General partnerships
The simplest and most common type of business partnership. Each member typically shares equal operational and legal liability, including day-to-day responsibilities as well as income and losses. This means that each partner’s personal assets can be used to settle the business’s debts.
2. Limited partnerships
An arrangement between a general partner(s) with unlimited liability and a limited partner(s) who maintains basic limited liability protections. Unlike a general partnership, in which partners typically share the workload, responsibilities and legal decisions, limited partnerships often are structured in such a way that the limited partner invests capital into the business but may take on less day-to-day responsibility. That limited partner’s total profit shares typically depend on the amount of capital they invest into the company and may be less or more than general partners.
3. Limited liability partnerships
A partnership business structure in which all partners benefit from limited liability protections. State laws dictate what type of business can or cannot become an LLP, but the eligible businesses are typically limited to professional service businesses, such as physicians, dentists, accountants and law practices.
| General partnership | Limited partnership | Limited liability partnership | |
|---|---|---|---|
| Type of owner | Two or more general partners | One or more general partner(s) and one or more limited partner(s) | Two or more limited liability partners |
| Management structure | All partners share equal control | Management responsibilities vary based on general and limited liability partners | Specific partner(s) manage and make operational decisions |
| Personal liability | All partners can be held personally liable. | General partners can be personally liable | All partners are protected from business liabilities |
| Tax classification | Partnership | ||
| Taxation | Pass-through. In a pass-through entity, owners report income and losses through their personal income taxes. | ||
How to form a partnership
General partnerships conducting business under their legal names are not required to register with their state or local government. Limited partnerships and limited liability partnerships, on the other hand, generally must file with their state’s secretary of state. We’ll walk you through the paperwork, but there are a couple of other steps you should take first to avoid some uncomfortable, costly or otherwise negative situations in the future.
Step 1: Choose your partners wisely
Though friends frequently enter into business partnerships, you may find more success choosing partners who bring certain knowledge, skills or capital to the new company.
Step 2: Create a partnership agreement
A partnership agreement spells out how much of the company each partner owns, how profits and losses will be divided and who makes legal decisions, among other things. It also provides the expected standard of conduct for each partner and a protocol establishing what happens if a partner leaves. Though not all states require an official partnership agreement, having one can benefit the business as well as your relationship with a partner(s).
However, Phillip Alber, a Michigan-based business lawyer, advised against the generic partnership agreements that can be found online, instead suggesting that a business attorney can help partners craft an agreement suited to the specific needs of the business.
Step 3: Seek expert counsel
Attorneys, accountants and industry experts can always be valuable resources when starting a new business. For instance, an accountant can help you and your partner(s) determine if a partnership is the most advantageous business entity, especially when it comes to small business taxes. (We’ll talk more about the tax implications of a partnership, below.)
Step 4: Register your business, if required
As mentioned earlier, as a general partnership, you typically wouldn’t need to register with your local or state government unless you and your partners decide to operate under a fictitious name, also known as “doing business as” or a DBA.
Limited and limited liability partnerships, however, will need to take that extra step before they can conduct business. You may need to file a certificate with your state’s secretary of state and pay a fee. Find your secretary of state’s website by searching here.
Obtain an EIN, licenses, permits and more
Aside from registering your business, you’ll also need to apply for an Employer Identification Number (EIN) and file for any necessary permits and licenses required to do business in your city or state. A business bank account can keep company funds separate from personal ones.
Starting a business partnership checklist
If you’re confident that the features of partnership suits your needs, as well as those of your partner(s) and the business in general, this checklist can help you and your partner(s) create a successful partnership.
Tax considerations of a business partnership
We mentioned earlier that all partnerships are considered pass-through entities, meaning that each partner reports income and losses through their personal income taxes. As such, the partnership itself is not required to pay federal income tax. Partners are taxed based on their distributive share, defined as the profits they received as part of their partnership agreement or, if no agreement was drawn, in accordance with state law.
Payroll taxes
Like any other business, if a partnership hires employees, the entity will need to meet federal and state (if applicable) payroll tax obligations. However, it’s important to note that partners should not be considered or taxed as employees.
Tax forms
Tax filing requirements can vary by circumstance, but here are some of the most common forms partnerships must typically fill out:
- Form 1065: This is the IRS form partners would attach to their personal federal income tax returns, along with their corresponding Schedule K-1 tax form. Form 1065 is used to report a partnership’s income, losses and deductions. Schedule K-1 identifies each partner’s share of the partnership’s income, deductions, credits and other items.
- Form 1040: This is the U.S. Individual Income Tax Return filled out by a majority of Americans. General or limited partners typically must attach Schedule SE to figure the tax due on net earnings from self-employment. You may be required to pay estimated tax quarterly.
Like the federal government, states generally do not tax partnerships; however, partners would most likely be required to report income on their personal state income tax returns.
Partnership vs. LLC
A limited liability company (LLC) can be made up of one or more members, and, like certain types of partnerships, offers members the benefit of certain liability protections. Because the two are so similar, choosing which one is right for your business can be challenging.
| General partnership | Limited partnership | Limited liability partnership | Limited liability company | |
|---|---|---|---|---|
| Partners/Members | Two or more partners | Two or more partners | Two or more partners | One or more member |
| Formation | Not required to register with the state government. | Typically must register with the state government. | Typically must register with the state government. | Typically must register with the state government. |
| Liability | All members are liable for business debts | At least one member is protected under limited liability laws. | All partners typically maintain some level of limited liability protection. | Members maintain limited liability from business debts and lawsuits |
| Taxation | Like partnerships, LLCs are taxed as pass-through entities. Unlike partnerships, LLCs may elect to be taxed as corporations by filling out IRS Form 8832. | |||
As you can see, the biggest differences between a partnership and an LLC come down to liability and flexibility at tax time. Members of an LLC are not personally liable for the company’s debts. However, certain types of partnership do provide the same kind of protection — they just require a bit more legwork to set up.