A partnership business entity, or a general partnership, is a business consisting of two or more owners who run their business in accordance with the terms of an oral or written partnership agreement. Although an agreement is not required, it makes sense to have one so that the partnership will run smoothly.
What is a General Partnership?
Simply co-owning rental property or sharing expenses does not constitute a partnership for tax and legal purposes. To determine whether a partnership exists, authorities consider:
- Whether a partnership agreement exists and if the partners have adhered to its terms.
- The parties' relationships with one another.
- What each person contributes to the partnership.
- The level of control each person has over the income of the partnership and how it is used.
Every partner may enter contracts on behalf of the business unless the partnership agreement states otherwise. Partners are jointly responsible for all business debts, obligations, and liabilities. This means that personal assets can be seized to pay these obligations.
Advantages of a General Partnership
With a general partnership, you can take advantage of a lean business model and make fast decisions on behalf of growth. This type of entity is usually inexpensive to create, though you may want to hire an attorney to draft a general partnership agreement.
Partnerships are taxed as pass-through entities, which means that each partner reports a share of business profits and losses on his or her individual tax return and pay self-employment tax. The business itself is not subject to income tax at the partnership level, though state and local taxes may apply.
A partnership should file with the IRS for an employer identification number (EIN).
Disadvantages of a General Partnership
The main negative aspect of a general partnership is the liability that partners must assume for business debts and obligations. This means creditors can seize not only the business assets but also partners' personal assets.
To avoid this risk, some entrepreneurs establish a limited partnership. With this structure, general partners still carry personal liability, but limited partners are only liable for the amount of their financial investment in the business.
What happens to a general partnership when one partner dies?
Coping with the death of a partner may be the hardest situation of all. When that happens, your deceased partner's share in the business usually passes to a surviving spouse, either by terms of a will or simply by default as the primary heir.
Arrangements should be made as you establish this partnership to take care for the event you may have heirs to be your partner.
Limited Liability Partnerships
In most states, limited liability partnerships (LLPs) can register with the state. With this structure, each partner's liability for business debts and obligations is limited to his or her direct actions.
Lillian Meyers CFP®, CDFA®, EA is a Tax Specialist, financial planner in North Bay Area, California helping clients live their best life through the use of financial planning, investment management, and other sophisticated financial options.