Historically, partnerships required no special formalities, but could arise simply by virtue of two or more people acting in concert for profit. Through the ages, this relationship has caused problems for some partnerships. Even today, individuals can face liability as partners based on their actions even though they never intended to formalize a partnership relationship. Increasingly, however, state partnership laws employ formal requirements and protections while retaining some of the form's traditional flexibility.
There are three modern partnership types: general partnership, limited liability partnership (LLP) and limited partnership (LP). A general partnership involves two or more owners running a business to make a profit. General partners share equally in the right and responsibility to manage the business, and any individual partner can bind the entity and all of its partners to a legal obligation. Each individual partner assumes full responsibility for all of the business's debts and obligations. Although this liability may be daunting, it has a tax advantage. The partnership is not taxed on its profits, but the partners are taxed on the profits and gains on their individual tax returns at a lower rate than the corporate tax rate.
Limited liability partnerships retain the federal tax advantages of the general partnership form, but offer some personal liability protection for participants. Individual partners to a limited liability partnership are not responsible for the wrongful acts of other partners or for the debts or obligations of the business. Because this form changes some of the fundamental aspects of the traditional partnership, some state tax authorities may subject the entity to non-partnership tax rules. The Internal Revenue Service views these businesses as partnerships, however, and allows partners to benefit from pass-through taxation for federal purposes.
A limited partnership allows each partner to restrict his or her liability to the amount of his or her business investment. Not every partner can benefit from this limitation. At least one participant must accept general partnership status with exposure to full liability. The general partner retains the right to control the business, while the limited partner does not participate in management decisions. General and limited partners benefit from business profits.
The unique liabilities of partnership businesses cause partners to maintain a more personal relationship to each other and to the organization. Partnership agreements recognize this issue and can help these businesses run smoothly. Such agreements settle management and operational issues, capitalization requirements and partnership limits.
Example: Smith, Smithe & Smythe is a real estate management partnership. During a lull in demand, the partnership experiences some losses. Smith calls for each partner to contribute additional money to keep the business going. Smithe believes that the partnership should cut its losses and terminate. Smythe feels that the partnership should add a new partner to infuse some additional capital into the business. The partners cannot agree on the proper course of action. An attorney can help to create a well-drafted partnership agreement that set limits on additional capital contributions, termination standards and new member admissions.
Like other businesses, a partnership must obtain necessary licenses, tax identification numbers and permits for legal operation. Many professional businesses operate in a partnership arrangement, and legal standards specific to the profession may apply in those cases. Business lawyers can explain the partnership options available in a particular state, and advise clients regarding the most appropriate entity for their business.
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