What is a partnership?
A partnership is a formal arrangement between two or more parties to manage and operate a business and share its profits.
There are several types of partnership agreements. In particular, in a partnership enterprise, all partners share responsibilities and benefits equally, while in others, partners have limited responsibility. There is also the so-called “silent partner”, in which a party is not involved in the daily operations of the company.
Key points to remember
- A partnership is an arrangement between two or more people to oversee business operations and share its profits and liabilities.
- In a general partnership, all the members share both the profits and the liabilities.
- Professionals like doctors and lawyers often form a limited partnership.
- There may be tax benefits for a partnership over a corporation.
How a partnership works
In the broad sense, a partnership can be any enterprise undertaken jointly by several parties. The parties can be governments, non-profit corporations, businesses or individuals. The objectives of a partnership also vary considerably.
In the narrow sense of a for-profit enterprise carried on by two or more people, there are three broad categories of partnerships: general partnership, limited partnership and limited partnership with limited liability.
In a general partnership, all parties share legal and financial responsibility equally. Individuals are personally responsible for debts contracted by the partnership. The benefits are also shared equally. The details of profit sharing will almost certainly be set out in writing in a partnership agreement.
When drafting a partnership agreement, an expulsion clause must be included, detailing the events which justify the expulsion of a partner.
Limited liability companies are a common structure for professionals, such as accountants, lawyers and architects. This arrangement limits the personal liability of the partners so that, for example, if a partner is prosecuted for professional misconduct, the assets of the other partners are not threatened. Some legal and accounting firms make an additional distinction between equity partners and employee partners. The latter is older than the partners but has no participation. These are usually bonuses based on the company’s profits.
Limited partnerships are a hybrid of general partnerships and limited liability companies. At least one partner must be a general partner, with full personal responsibility for the debts of the association. At least one other is a silent partner whose liability is limited to the amount invested. This silent partner does not generally participate in the management or the daily operation of the partnership.
Finally, the ill-named limited liability partnership is a new and relatively rare variety. It is a limited partnership which offers greater protection against the liability of its general partners.
These fundamental varieties of partnerships can be found in all common law jurisdictions, such as the United States, Great Britain, and Commonwealth countries. However, there are differences in the laws that govern them in each jurisdiction.
The United States does not have federal law defining the different forms of partnership. However, all states, except Louisiana, have adopted some form of the Uniform Partnership Act; laws are similar from state to state. The standard version of the law defines partnership as a legal entity distinct from its partners, which departs from the previous legal treatment of partnerships. Other common law jurisdictions, including England, do not view partnerships as independent legal entities.
Taxes and partnerships
There is no federal law 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. Tax liability rests with the partners, who are not considered employees for tax purposes.
Individuals in partnership can benefit from a more favorable tax treatment than if they founded a company. In other words, corporate profits are taxed, as are dividends paid to owners or shareholders. The benefits of partnerships, on the other hand, are not taxed in this way.